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Healthcare Investing

This Article was Originally Published in CityWire USA, ProBuyer Magazine

November 5, 2018

We recently had an opportunity to speak with Dr. Daniel R. Omstead, Ph.D., Chief Executive Officer of Tekla Capital Management LLC and President and Portfolio Manager of each of the Tekla Funds. Tekla Capital Management LLC is a registered investment adviser based in Boston, Massachusetts that focuses on Healthcare investing. In this interview, Dr. Omstead provides commentary on the healthcare market today and an outlook into where we go from this point.

Healthcare has performed well this year, and is the third best performing sector in the US, far outperforming the wider index until September. What has been driving this and can it continue?

I think it’s all based on fundamentals. Healthcare is a very large part of the economy. It’s an area in which great progress is occurring, new technology is being developed every day, and you have a whole new generation of products and solutions being created. Furthermore, healthcare tends to be a defensive sector at a time when the market is at the high end of its valuation range. So, all those things together, I think add up to healthcare being a good place to invest.

I expect these trends to continue. Added to this, however, is a huge demographic tailwind. As people get older, they spend more money on healthcare and drugs. This demand can only be adequately met with new and novel products addressing unmet medical needs. It is the coalescence of change occurring for the individual, the sector and the economy that should help healthcare as an attractive investment looking ahead.

Are you worried about political developments – particularly the rhetoric surrounding drug prices?

Of course. You always want to make sure that companies are providing good value in the marketplace.

There are many different kinds of healthcare products, but the ones that we generally focus on are those that are novel and based on new technology. Compared to old-style drugs, in our view, most are fairly valued and are addressing unmet medical needs.

For example, if there is a third product to treat some particular form of cancer and it’s a slight modification of an existing product, we are less interested than we are in a differentiated product that treats a disease that is otherwise unable to be treated. That should give us some cushion if pricing rhetoric does escalate. I don’t think pricing is going to be as much of an issue for novel products that meet unmet medical needs, in comparison to the third, fourth or fifth product to treat an otherwise tolerable or treatable condition.

I generally agree that we have to decrease the overall cost of drugs and the trend looks to me like marginally differentiated products will have more price pressure than novel products. Since we focus on the latter, it’s less of a problem for us, but we do keep a close track on these developments.

You manage four funds, some of them quite different. Can you explain them?

We have four closed-end funds that are designed to address a somewhat different profile of investor.

Two, Tekla Healthcare Investors (HQH) and Tekla Life Sciences Investors (HQL), are pure equity funds that are very much growth-oriented. They invest almost entirely in equities, have a substantive contribution of pre-public venture investments and, like nearly all closed-end funds, make a distribution. That distribution comes quarterly and preferentially in the form of new shares. These Funds have been around since 1987 and 1992 respectively, and they’ve produced what we view as an acceptable return as well as delivered a distribution that is largely characterized as long-term capital gains. We also know that some investors want a blend of growth and income. So the two products which we have most recently created, Tekla Healthcare Opportunities Fund (THQ) and Tekla World Healthcare Fund (THW), are more growth and income oriented. They are still mostly invested in equity, but also invest in the debt of healthcare companies and use option strategies and some leverage to create more income. In general, we seek to have a significant portion of the monthly distribution in these Funds come from income.

In summary, HQH and HQL are equity focused, making quarterly distributions, mostly in the form of new shares. THQ and THW are growth and income-oriented and have a combination of gains and income supporting their monthly cash distributions. At the same time, THQ is mostly a domestic US-based fund and THW has a large asset allocation outside the US.

'We see a number of net positives for healthcare today. Biotech, which often leads the league in healthcare, isn’t leading at the moment.'

What is your investment approach? How is it different from your peers?

Our analysts have strong scientific backgrounds which we believe gives us a competitive advantage. These analysts have a combination of very good academic and

industrial experience, as well as investment experience. The majority of our analysts are MDs or PhDs, rather than MBAs, although we certainly have a cadre of MBAs. Many of our analysts, myself included, have spent time working at big pharmaceutical and/or biotech companies.

Not only do we understand the basic science, but we have also been fortunate enough to obtain substantive experience in the development of drugs and regulatory interaction with the FDA and ex-US regulators. Given this, we’re able to use our combined knowledge of basic science and regulatory strategies to augment traditional investment techniques. This multi-disciplinary approach allows us to adopt a differentiated opinion, which hopefully permits us to make calls that produce profits for our shareholders.

In terms of the companies, what sort of firms are you looking at? Do you have a particular selection criteria?

The two initial Funds, HQH and HQL, invest in a number of small- and mid-cap companies, biotech oriented companies in particular. HQL tends to have a larger allocation to small- and mid-cap stocks than does HQH. THQ and THW tend to focus more on mature, larger cap companies. The reason for this is that small- and mid-cap companies tend to exhibit better stock appreciation, but little to no income, while larger cap companies can offer a combination of growth and income. We think that such size differentiation works well with the goals of the respective Funds. So, we are trying to match the goals of each Fund with the allocation and the selection of companies.

How are investors using the Funds? Is it to gain healthcare or income exposure?

Many of our investors are interested in income. Our first goal is to make sure we invest in a way that allows us to reliably produce a dividend. The Funds’ Trustees determine the distribution policy for each Fund, but our goal as an investment adviser is to do what we can to make sure the distributions under the policy can continue. From what we are told by investors we speak to, the overriding sentiment is a wish for a consistent distribution in addition to a respectable return.

I think most people, regardless of whether they are growth or income focused, want to understand how these Funds are going to operate and how they’re going to produce that distribution. From our interactions with shareholders, it seems that many see these Funds as long-term investments. We have many financial advisers that use one or more of our Funds to help them augment their own advice to shareholders about healthcare or biotech. While we have some investors who appear to be short-term oriented, many of our shareholders appear to be long-term oriented.

'The healthcare sector is holding its own or better and the whole world is generally up.'

Obviously, that long-term focus, is that because people appreciate that you guys are trying to tap into both innovation and also some of those demographic changes that are occurring?

It seems so. Hopefully the fact that our Funds have been around and investing in healthcare in general (and in biotech innovation in particular) since 1987 gives our shareholders a level of confidence that we will be around for the next thirty years.

You have decades of pharma experience and nearly two decades of investing experience. What keeps you motivated and driven?

It is easy for us to stay motivated. Almost every day, we get one or more CEOs in our office telling us how their products are going to change the world. They describe new and novel drugs, devices and services that will save or extend the lives of ill patients, treat previously unaddressed diseases, reduce pain and suffering and the like. Learning about these things is interesting and educational. In order to make money for our shareholders, we have to of course choose the products, companies and managements that will be successful. But when we are right it is gratifying to feel that one’s efforts have, in some small way, helped to improve the safety and wellbeing of patients who need help. I really can’t think of a more rewarding and motivating thing to do.

Tekla Capital Management LLC is a registered investment adviser based in Boston, Massachusetts and is the investment adviser for four closed-end funds, Tekla Healthcare Investors, Tekla Life Sciences Investors, Tekla Healthcare Opportunities Fund and Tekla World Healthcare Fund. The Funds predominately invest in the securities of public and private healthcare companies.

OVER $3B AUM IN FOUR EXCHANGE LISTED FUNDS (HQH, HQL, THQ & THW)

The material contained in this interview is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors. There can be no assurance that any closed-end fund will achieve its investment objective(s). Past performance does not guarantee future results. The net asset value of any closed-end fund will fluctuate with the value of the underlying securities. Historically closed-end funds have often traded at a discount to their net asset value. The distribution rate and income amounts reflect past amounts distributed and may not be indicative of future rates or income amounts. Distribution rates and income amounts can change at any time. Investors should consider the investment objective and policies, risk considerations, charges and ongoing expenses of an investment carefully before investing. For more information, please contact your marketing and distribution agent, Destra Capital Investments LLC at 877.855.3434.