In Search of the Perfect Investment

My investment philosophy is simple:

+ If I have control, I bet the farm.

+ If I don’t, I bet on diversification, with my “insurance” being tight stops.

The “big” key is the risk I perceive. To me, the worst risk is, “Can I lose all of it?” That’s the question I ask of all potential investments — especially those that are private, and hence illiquid. I can’t sell them from one one moment to the next. If I go for illiquid assets, I prefer “hard” assets — like lightly-leveraged real estate.

In stocks, diversification means starting small, learning the stock and buying more as I feel more comfortable.

Sometimes that backfires. Over time, I’ve bought a lot of Berkshire Hathaway. Lately, it has underperformed — done worse than the S&P. There is some hope things might improve with upcoming higher earnings — see this piece in Seeking Alpha.

Everyone and their uncle has theories on how to manage their portfolio.  You can run it yourself (my preference), or rely on “professional” managers, which has another set of issues — one of which is pretending that this business of investing is actually “scientific” — when it’s actually a learned skill. Here’s an excerpt of an article showing what some investors are doing. To me, it’s just another marketing gimmick fed to naive investors. There’s no substitute in this business for learning it yourself — no matter how busy you are at your “day” job.

Individuals Find Ideas in the Institutional Investment World
By PAUL SULLIVAN, New York Times, Nov 22, 2013

MAYBE the Standard & Poor’s 500-stock index crossing 1,800 this week is a sign of a stock market bubble, or maybe the companies that compose it will continue to grow. There are arguments for both, but the correct answer will be clear only at some point in the future.

For investors trying to make rational decisions about their portfolio today, this is little comfort. The chatter can be scary. And advice like “stay the course” is about as helpful as telling someone to stop worrying and be happy.

Sure, there are plenty of advisers working with their clients on financial plans. But these plans can be too general and easy not to follow. Recently, I started hearing more about advisers who were adapting something from the institutional investment world for individual clients: investment policy statements, which are commonly used by foundations and endowments to create parameters for how securities are bought and sold and guidelines for making changes to holdings and hiring and firing managers.

An I.P.S., as it is known, is to a financial plan what a Range Rover is to a minivan. Both will carry your children safely, but only the Range Rover will power up a gravelly mountain. Of course, most people who own a Range Rover are traveling the same, well-paved suburban streets as the minivan driver, making all that engineering a bit of overkill.

To some, the same argument can be made for an I.P.S. It’s just too much. But the people I spoke with who had one talked about a difference in their investment performance and their state of mind.

Robert McCarthy, a lawyer who held senior positions at MTV, Viacom and Time Warner, said he started working with an adviser who uses an I.P.S. in late 2009. “I was very chastened,” he said. An I.P.S. “was a guide to the level of risk in each portfolio.”

Like many, though, Mr. McCarthy came to this the hard way. He is on his third adviser since big losses in 2000 and 2008. The same thing happened with David A. Gelb, a periodontist with expertise in implant surgery. His portfolio today is the same value as it was in 2000, before it dropped by nearly two-thirds. Now he is a true believer when it comes to an I.P.S.

“I said, `My God, why didn’t any of my other advisers ever discuss something like this with me?’ ” Dr. Gelb said. “If you don’t have an objective or a game plan, how predictable can you be?”

In its structure, an I.P.S. is fairly simple. Investors sit down with their advisers and assess their return objectives and comfort with risk. Then the adviser designs the portfolio with that in mind. Where an I.P.S. goes further than a financial plan is that it sets a target allocation for each type of security – say, stocks – and adds an upper and a lower range for the percentage of the portfolio that can be in that security.

In the case of Mr. McCarthy, the I.P.S. for him and his wife sets a target of 40 percent for stocks. That percentage can go as high as 60 percent and as low as 20 percent.

“If I get nervous about the state of the stock market and say, `This is too frothy,’ the exposure gets reduced, but it won’t go below the minimum equity number,” he said. “But market performance can have that effect, too. If you go over the maximum number, it gets reduced.”

The idea is to keep people from getting so bullish that they overcommit to a sector and lose when it inevitably falls, or so bearish that they sell their investments and go to cash.

“This is standard operating procedure for an endowment, a foundation or a pension,” said John W. Rafal, the founder and vice chairman of Essex Financial Services, which manages approximately $4 billion for individuals and institutions. “After the crashes of 2000 through 2003 and then the crash of 2007, ’08, and ’09, we thought this would give our clients the same protections we give to pensions.”

Beyond establishing the ranges for a particular type of investment, Mr. Rafal says he asks clients about their investment history, comfort with risk and knowledge of asset classes but also about their family history, education, sophistication, views on giving money to charity and their children and, ultimately, use for their money.

“It’s to keep everyone rational in irrational markets,” he said. “It’s never going to be perfect with an individual, but it’s better than if you have no policy.”

… Of course, a full-blown investment policy statement for an individual is only as useful as what it contains. “Some are two pages and don’t have enough detail, and some are so long that no one is ever going to read them,” said Pat Boyle, investment strategist at Bessemer Trust. “The best ones are three to five pages, and they’re written in English, not by attorneys.”

… “The purpose of an I.P.S. is essentially to put some discipline and structure around an invest strategy,” said Scott Koch, senior vice president at Northern Trust Wealth Management. “But one of the questions you first have to ask is why is the strategy what it is in the first place. If you don’t understand the why, it’s hard to adhere to any discipline.”

Even with an I.P.S. most investors are still going to be subject to some degree of emotion in their investing. “I don’t feel handcuffed by this thing, but it’s been a useful tool,” Mr. McCarthy said. “My advisers push back when they feel I’m overreacting to things.”

And that will mean more than someone saying, “Stay the course.”

How to pick health stocks. The theory is Obamacare will increase health spending. Hence buy healthcare stocks. The no-brainer buy is XLV, the healthcare ETF:

Other stocks include GILD:

I also own JNJ:

My only other healthcare stock is something called HeartWare, which, like all healthcare companies with a single product, has had a rocky road.

I’m disinclined to put more money into healthcare. But I keep reading and mulling. The thoughtful piece is from this week’s New Yorker highlights how more people are actually shopping for their health-care procedures. Good idea to check the bills also. When I asked about some charges from the hospital in which my cataract surgery was done, they simply removed the charges. I don’t know why they were in the first place. And I don’t know why they removed them. The healthcare “business” makes little sense, except that everyone overcharges and seeks to lumber you with frivolous tests.

Controlling Health-Care Costs
by James Surowiecki

When it comes to health care, all anyone can talk about these days is Obamacare. And, while that may be understandable, the political furor over the program has obscured a quieter but arguably more consequential development: health-care costs in this country may finally be coming under control. As a new report from the Council of Economic Advisers details, after half a century in which medical spending has well outpaced G.D.P. growth, something has changed. From 2007 to 2010, per-capita health-care spending rose just 1.8 per cent annually. Since then, the annual increase has been a paltry 1.3 per cent.

The slowdown in spending is due in part to the recession and the tepid recovery-but not as much as you’d think. A recent paper by the Harvard economists David Cutler and Nikhil Sahni estimated that the recession explained scarcely more than a third of the spending slowdown. Oddly enough, the public debate over Obamacare has also played a role. Bob Kocher, who was a special assistant for health care in the White House in 2009 and 2010, did a report for Lawrence Summers on the past sixty years of health-care legislation, and found that when Congress seriously considered enacting health-care reform the rate of health-care spending often slowed for a year or two. Just talking about medical costs, it seems, limits medical costs. Kocher, a physician turned venture capitalist (and currently a guest scholar at the Brookings Institution), dubs this “the health-care-policy placebo effect.” As he told me, “When you’ve got politicians going around the country making speeches about how out-of-control health-care spending is killing the economy, health-care providers come to feel that it might make sense to be less aggressive in setting prices.”

Both those effects are bound to be temporary. But there’s good reason to think that the moderation of health-care spending will persist, because, according to Jason Yeung, an investor at Morgan Stanley’s Growth Team, we’re beginning to see deeper structural changes in the health-care system. Historically, costs have been hard to contain because most of the players in the system have had no incentive to do so. Hospitals and doctors have typically been paid on a fee-for-service basis: the more things they do, the more money they get. Insured patients have paid only a small fraction of the cost of their care, and insurers have just passed costs along to their customers. Employers and the government, meanwhile, have been left to foot the bill. “What we’re moving toward instead is a world in which everybody in the system is sharing financial risk,” Yeung told me. “And therefore everybody has an incentive to control costs.”

For consumers, this means higher deductibles and co-pays, and having to think more about prices. A peculiar feature of the American health-care system is the enormous variation in prices that hospitals charge for a procedure, which often are not correlated with quality. So in 2011 California adopted a system of “reference-based pricing” for state workers and retirees. If you needed hip-replacement surgery, say, the state would cover you for the amount charged (minus a deductible) at forty-one “value” hospitals in the state. If you went for a costlier option, you had to make up the difference. Most people chose one of the value hospitals, and their outcomes were similar to those of people who chose the more expensive hospitals. The state saved money, and the threat of losing customers, in turn, led the more expensive hospitals to cut prices; one study found that the price of joint-replacement surgery fell by about a third.

The success of the experiment has inspired other players-like the insurer WellPoint-to follow suit. Meanwhile, a McKinsey study of almost a thousand plans on the A.C.A.’s health-care exchanges found that nearly half had narrower networks of hospitals and doctors than most plans currently offer. Narrower networks let insurers push their customers toward cheaper hospitals, and also give them more leverage in bargaining down prices.

The Affordable Care Act is also helping hold down costs by changing incentives for hospitals and doctors. For instance, it penalizes hospitals when Medicare patients with certain conditions are readmitted within thirty days, on the assumption that this will encourage hospitals to offer better care initially, and to be diligent in following up. And the penalties are having an effect-since the A.C.A. passed, readmission rates have fallen. “Once hospitals feel that gut reaction of not getting paid when the patient has to be readmitted on the twenty-fifth day,” Yeung says, “that reverberates through the whole system.”

What all these initiatives have in common is the idea that health-care providers are going to be paid based on the value they deliver, rather than on the services they perform. We’re in the early stages of that process: Kocher points out that fee-for-service likely still accounts for more than ninety per cent of health-care spending. And changing the system is going to be politically challenging. In theory, after all, reining in health-care spending sounds great. But in practice things like narrower networks limit patients’ ability to see the doctors they want, while less money spent on health care means lower incomes for many doctors and hospitals. So some blowback is inevitable. Still, the changes we’ve seen in the past few years are going to be difficult to stop, because just about everyone now recognizes that when it comes to health care we spend far too much for the results we get. “No one knows when things are really going to change,” Yeung said. “But, even if you’re in a room with no clocks, you can know that when it strikes midnight the world will be different.” 

Favorite recent New Yorker cartoons:

Harry Newton who feels comfortable that (1) We’re not in a stock bubble, (2) The portfolio listed in the right column will still hold up nicely and (3) It’s critical to watch it daily. Tweaking works, especially as some stocks become cockroach. I’m still short LL and IBM.