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TMFHelical (99.05)

Helical Port Feels the Pain – 5/31 Update

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June 03, 2012 – Comments (11) | RELATED TICKERS: MAKO.DL , GHDX , WLP

It has been a couple of months since I last updated the Helical portfolio.  At that time it was riding high, as was the market.  Since I had a cautious outlook on the year, I had been raising cash throughout the first quarter.  That seems prudent in short-term hindsight, but there was another item that was not so well considered.  The Helical portfolio is a concentrated, monolithic (behavioral framework of risk weighting) collection of equities all from the healthcare sector.  As a concentrated portfolio with ~1/3 invested in what I consider to be high risk equities, volatility should not be a surprise (but still can hurt).  I try to have a few guidelines to mitigate the portfolio risk, but was sadly lax in applying them.  Nevertheless, the portfolio ends May still in decent shape on the year to date (details to follow).

Update

Since the Q1 update where I detailed the holdings, there have been three significant changes in the portfolio.  The first is I added money as I had indicated.  This real account is my Roth, so a $5000 addition was made on April 11 (2011 contribution made with just days to spare).  There is nothing like adding money to keep a portfolio healthy, growing, and headed toward one’s goals.  As noted in the Q1 update, I sold a portion (60%) of my holding in Wellpoint (WLP) and will wait for the Supreme Court ruling on the affordable care act to consider when to add it back.  So far so good, as I sold at $73.17 and it is $66.36 today.  I hope to get a still better price sometime soon (we’ll see) and expect I will be wanting to make Wellpoint a significant portfolio holding (and maybe add UNH as well).  There were no other transactional changes in the portfolio since the Q1 update, other than the collection of $111.39 in dividends and interest.  The third significant event was MAKO Surgical reported its first quarter results, and got crushed!  I’m going to pass on the relatively insignificant quarterly reporting of the other portfolio holdings to focus on the MAKO disaster.

MAKO

Always first, start with the investment thesis.  MAKO was added to the Helical portfolio on 4/28/2011 with 200 shares for $5426.99 ($27.10 plus $7).  It is lower today at $21.62.  I noted at the time ”I need to know more about MAKO, and may simply be trying to recreate the magic that was Intuitive Surgical with a less then comparable related asset -- but we'll see.” That is a pretty lean thesis (OCD: than not then – doh!).  Now I don’t mind at all speculating in the ‘high risk’ portion of my portfolio.  But at the end of March, I had allowed MAKO to become 12.6% of the portfolio, a bit rich.  Worse still, despite knowing that Q1 was a historically weak quarter for MAKO, I allowed my mindset to be all upside focused, and did not adequately consider the possibility of the company not meeting expectations.  The Fool (collectively, individual opinions differ) has had and continues to have a high opinion of this equity, I let that color my own consideration of the holding perhaps a bit too much.  I was considering trimming ‘after earnings’ on the expectation of good ones, and not protecting the portfolio from poor earnings.  Poorly considered in hindsight.

MAKO’s growth stalled.  It will take another couple of quarters to determine if this stall was simply a blip in a continued growth story, or has a basis in a flaw of the company and its products.  MAKO sells a very expensive piece of robotic equipment into a market (knee surgery) that has been flat of late, may be over-prescribed (unneeded procedures) in the US, and has lower cost competition.  While it has expanded the instrument use to hip procedures, utilization in terms of total number of procedures is modest.  This is still a nascent market, and the potential is large, so I think it still worth the speculation.  A key item that nags at me is ‘value’.  Not for the equity; I’m unconcerned with valuation efforts here, as I believe the assumptions necessary for all but a relative valuation are too unknowable.  Instead I have yet to be convinced that the procedure itself adds value to the payers.  Management talks about the need to convince payers that the use of their equipment makes economic sense, but talks of little more than this need i.e. they don’t well explain ‘how it makes economic sense’.  I can speculate that it could, specifically in reduced hospital times and the need for follow-up appointments, but I want to see a study / hear this case presented in detail, and I have not yet.

Reframing the Risk from MAKO – The Lesson

I like irony, and so I find some in that the one line ‘thesis’ written for MAKO on the buy, was noted in a blog post on portfolio risk guidelines.  Specifically, from portfolio risk review perspective, I want to avoid losing 6% of the portfolio in any given month, and not more than 2% of the portfolio in any one holding.  Given that the higher risk, more speculative holdings in the portfolio could well lose 50% on a poor earnings call, as MAKO did, it was not prudent to allow this to become > 12% of the portfolio without protection.  I hesitate to use options for this, but I may at some time.  It is easier to control position size.  And while, yes, this does limit the upside on a speculative position when I am ‘right’, I find it better to balance the potential gains against those for loss.  At the end of Q1, I considered 4 of my holdings as ‘speculative’.

33.1% High Risk ----------- BRLI (6.9%), GHDX (8.7%), MAKO (12.6%), MR (4.9%) 

If I am unwilling to lose 2% of my portfolio to any one holding, and these high risk speculative positions are considered as having the potential to drop 50% at any time, then perhaps it makes sense to not allow any one of these to be over 4% of the portfolio.  But does it??  This is the investors dilemma, the Friedman-Savage puzzle that makes risk personal and not inherent.  It defines the balance between taking on risk for the promise of gains and preserving wealth, and forms the basis of Prospect and Behavioral Portfolio theories.  It is why I consider myself first and foremost a behavioral investor (and not style-boxed as growth, value, etc.).

I want the Helical portfolio to be relatively high risk.  It is by virtue of being single sector (though the healthcare sector is relatively low risk and quite broad).  I have an IRA that is larger and more conservatively invested, so I can accept a bit more risk here.  Still, the 6%-2% is a good guideline, though based more on a trader’s mindset than investors.  Bottom line, I’m going to accept a speculative position of more than 4% of the portfolio, specifically, up to 8%.  I’ll let a position run, but once it sees 10% of the port, I’ll consider trimming (these are all guidelines after all, not algorithms).  Loss of more than 6% of the port and 2% to any one holding will always trigger review (blogs are great for that), but not necessarily activity.

So, where am I today with the high risk holdings, after adding cash and the losses from MAKO?  After May 31, this portfolio segment was:

26.9% High Risk ----------- BRLI (5.7%), GHDX (10.0%), MAKO (6.7%), MR (4.5%) 

These are in range, except for Genomic health, which is getting a bit rich.  I should take some of the gains I’ve had here off the table (going to have to wait a few days).  This is not for any company specific reason, but for portfolio management considerations.  I’ll look for another speculation once I’m comfortable redeploying cash, but I expect that to be a few months off.

Getting to the Portfolio 

After May 31st, the Helical Portfolio stood at $67,409.23 (It was $72,256.04 after April).  The portfolio did lose over 6% in the month, and the reaction will be to trim a bit off Genomic Health, a speculative position that is a bit rich in weighting (as noted).  ICON plc is the second highest weight holding, but I’ll give that a bit more rope.  The portfolio is just over 30% cash.  Last year I went as high as 50% cash, and would rather not do that again.

The portfolio is up year to date 19.7%.  That is what adding cash can do for an investor.  Ignoring the cash (which was not deployed), the account would still be up 10.8%, still well ahead of the market. With the addition of cash, I find I must now consider IRR. The annualized return (XIRR from excel) on the portfolio since inception 17 months ago is 16.5%. That is well ahead of both expectations, but a bit irrelevant given the short time frame.  I’d love to beat 8-10% annualized long term. It is nice to be ahead of goals as it does not induce pressure to try to ‘make up’ and enables comfort in holding a high % of cash, which will erode return metrics in the short term.

So far, so good but I still wish I’d been less hoodwinked by MAKO (i.e. more coscientious of the risk).

Ralph

Helical Investor 

11 Comments – Post Your Own

#1) On June 03, 2012 at 3:49 PM, TMFHelical (99.05) wrote:

It was very difficult to make this blog post - literally.  TMF would not accept the post without kicking out an error message, and so I had to put the post in a few sentences at a time.  Still there were some thing that would not add without giving an error.  For example.

This is the investor’s dilemma, the Friedman-Savage puzzle that makes risk personal and not inherent. 

For whatever reason, the blog post would not post with the hyperlink present in this sentence. I have no idea why (works fine in the comment).  Also, the following sentence had to be rewritten or the post would not stick.

Using the excel IRR function, the annualized return on the portfolio since inception 17 months ago is 16.5%. 

Wierd and aggrevating.  It took a few rewrites before the sentence wouldn't generate a 'spamming' like error message.  Anyway, its up now.  Comments welcome.

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#2) On June 04, 2012 at 7:24 AM, rtichy (36.15) wrote:

tried to comment last night but it didn't show up?

 

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#3) On June 04, 2012 at 7:25 AM, rtichy (36.15) wrote:

I bet I only previewed and didn't follow through with the post button

 

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#4) On June 04, 2012 at 7:38 AM, rtichy (36.15) wrote:

Ralph,

 6% seems like too small a drop to be willing to suffer in a higher risk portfolio; also, after the fact, if you measure against broader market performance measures, dropping 12% isn't such a problem if the market went down 10% in the same month's time, right?

 Are you going to hedge your loss exposure by buying options, because i would not want to reduce the amount of MAKO in the portfolio just because it ran up (better) than the rest of the portfolio.  You made the allocation based on invested cost at the time of investment; shouldn't you let that first allocation stand for some period of time before considering any reduction for outstanding performance?  (You put $5500 into MAKO from the start, which was probably 10% of portfolio to begin with.)

 There is a situation that makes me consider jumping back out of a stock in a very short term and that is when I buy it and it immediately pops a lot, just through good luck... that always says to me that I should take my money back out because I had no rational reason to expect that "performace" and that it will probably close the gap over time before returning to performance closer to original expectations.   Example I followed SpOps and got into HTH Apil 23.  By May 7th I was up 40%; this makes me want to pull out of HTH.  Example A decade go I bought some Agilent at $40 and a week later a WSJ article ran about a potential use of inkjet tech in optical fiber switching (using water vapors!).  Agilent went to $140, (it was strange times!) and I stayed in.  Of course over time $140 became$40 again (and still is!)...  crazy pops are free money that you can watch wither away.

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#5) On June 04, 2012 at 7:39 AM, rtichy (36.15) wrote:

Also, don't forget that portfolio rebalancing goes strongly against "letting your winners run" like David G suggests!

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#6) On June 04, 2012 at 10:48 AM, TMFHelical (99.05) wrote:

rtichy

6% seems like too small a drop to be willing to suffer in a higher risk portfolio; also, after the fact, if you measure against broader market performance measures, dropping 12% isn't such a problem if the market went down 10% in the same month's time, right?

This is a portfolio, not a stock selection.  6% is significant on the portfolio level - especially monthly, and market measure largely irrellevant (just makes things easier or harder, but the goals remain the same).  It is also not an automatic sell signal, but one that trigger 'evaluation'.  I dropped 6% last month, but already have a decent cash cushion and reduced risk profile on the port.  I'm therefore only making minor adjustments. If I drop 6% again in June, I'll reevaluate again.  I'm still willing to take significant risk here, but more measured.

Are you going to hedge your loss exposure by buying options, because i would not want to reduce the amount of MAKO in the portfolio just because it ran up (better) than the rest of the portfolio.

No plans to do this yet.  I wouldn't say never but none are planned.  Options in a Roth can be problematic anyway (depends on broker and type of option).

You made the allocation based on invested cost at the time of investment; shouldn't you let that first allocation stand for some period of time before considering any reduction for outstanding performance?  (You put $5500 into MAKO from the start, which was probably 10% of portfolio to begin with.)

Part of the lesson learned is I overcommitted in my initial investment.  In my defence, 10% of my Roth is not a large % of my total investments.  But, I'm trying to work this portfolio as a stand alone as part of my own learning process.  I overcommitted for a cheery consensus.

Also, don't forget that portfolio rebalancing goes strongly against "letting your winners run" like David G suggests!

Yeah, that is not for me.  David has all but noted in the run up to Supernova that his strength is stock selection, not portfolio management, and that he doesn't have a well defined sell strategy.  I don't either,  just triggers for reconsideration.

In any case, this is all a work in progress, and always will be.

Ralph

Helical Investor

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#7) On June 04, 2012 at 2:14 PM, ikkyu2 (99.22) wrote:

Appreciate your post very much; I love looking over folks' shoulder to see their reasoning and then a detailed report of the outcome and that's just what you've done here.  This is the best way to learn and improve.

Have some thoughts to offer: they're no better or worse than your thoughts, they are just my thoughts, so please take them in that spirit.

When I buy 'speculative' names, I like to try to buy 5 at a time, expect one to tank, 3 to perform in-line the market, one to pull a ten-bagger.  For this reason I do try to identify 5 names at a time, I try to make them all names I think have a shot to pull a ten-bagger, and - most pertinent here - I limit position size on each of these names to 2.5% of my total portfolio.

I should also point out that I have tried this now 5 times in the last 7 years - that's 25 names - and I have yet to have any of them pull even a one-bagger (although SIRI and MGM both would have done if I'd had the guts to hold them a little longer.)  I've had 2 names (JMBA and PTN) lose most of their value, as well; although that's matched by the two large-cap, blue-chip names I've also held as they lost 90%+ of their value (GM, LEH), so clearly 'specs' have no monopoly on tanking.

You are outperforming the S+P 500, as near as I can tell, so don't beat yourself up too much.  Once you make the decision to be in equites, any portfolio devoted to equities should actually be measured this way.  I find that year over year, I outperform the S+P by 20-25% very consistently, even with the problems I mentioned above.  I lost money in 2008 - but I still outperformed the S+P by 23%.  Since I can outperform by 20-25% on average, there is no reason for me to beat myself up for losing money in equities in 2008 - any intellectually honest person would have expected me to do so.  

In other words, if you want to participate in the (historically excellent, long-term) price movement of equities: participate in all of those price movements!

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#8) On June 04, 2012 at 2:24 PM, ikkyu2 (99.22) wrote:

Now let's talk specifics.

With regard to MAKO, I think you're confused about who the 'payers' are.  The ones deciding whether or not this equipment is going into OR's are hospital admins.  They are considering two things: surgeon satisfaction (they don't want their surgeons to take their money-generating procedures to another center) and OR turn time.

This really boils down to OR turn time.  Having an O/R open for 1 hour entails a lot of fixed costs; nursing admin, scrub nurse, circulator nurse, anesthesia staffing, sterility maintenance, variety of techs and couriers, pathology staffing, HVAC guys on-call, etc etc etc.

If using MAKO can cause an OR to turn out one additional knee per day in the same amount of time (usually 8-10 hours) that the OR is open, surgeons and hospitals will both crave that intensely because it will go straight to their bottom line, boosting it.  Other concerns are peripheral.   If it can't do that, there is no reason for either hospitals or surgeons to want to bother with the initial fixed costs (both in installation and in surgeon re-training).  I don't actually know if MAKO's product can do this, but if an OR turn time statistic is not blazoned in foot-high letters at the top of every marketing pamphlet and quarterly report, I would advise you to sell the hell out of that stock as they do not know what they are doing.

"Follow-up visits" is a total red herring, as they don't happen in the hospital and the insurance companies have to pay for them if they're necessary.  A knee costs the payers $50K; a follow up visit costs, what, $50?  No one cares if there are 2 f/us instead of 3; it's immaterial.  "Patient satisfaction" is truly immaterial because it does not go to bottom line. 

I would not touch a healthcare company with a 10 foot pole right now; these are heavily managed, top-heavy companies, laden with bean counters and cost cutters and consultants; all battling valiantly, guns a-blazin', for an ever shrinking piece of an ever shrinking pie.  The EHR boondoggle is going to be the biggest money loser any industry has ever seen; hospitals are paying $150 million + apiece for the privilege of installing software that is going to reduce their productivity on average 13% (real numbers!)  The first year, they're subsidized by the government to do it; the next 10 years, they're locked in.  This is going to start showing up on balance sheets in 2014 or so but the smart money sees it coming already.

My 2 cents.  There probably is a market for niche providers of specialized services; and UNH with their Ingenix is clearly the way of the future, although boy are they angering providers right and left.  I'd be interested in hearing more about Genomic Health if you chose to post about them. 

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#9) On June 04, 2012 at 11:57 PM, TMFHelical (99.05) wrote:

ikkyu2,

I agree with you about spreading out the speculative selections.  But they do get tempting at times.

I disagree that I am confused on MAKO.  Yes, the 'customers' are the centers and physicians.  But they care very very much about reimbursibility.  Follow-up and hospital time is not a red herring, it is the way things are increasingly measured.  Make the value case to the payers, or suffer the consequences.

EHRs will revolutionize healthcare, but it will be painful.

Genomic Health is a diagnostics company who pitches a value proposition directly to payers, telling them which patients will not require (or benefit) from expensive therapy.  This is a company embracing the new sherriffs in town.

Ralph

Helical Investor. 

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#10) On June 10, 2012 at 2:20 PM, ikkyu2 (99.22) wrote:

Ralph,

What is the MAKO product's effect on OR turn time for total knee? 

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#11) On June 11, 2012 at 3:30 PM, TMFHelical (99.05) wrote:

ikkyu2,

The MAKO robot does not do 'total knee', but a more limited partial knee procedure.  A more limited market. I don't know the OR time, but expent it is lengthy.  I don't think there will be multiples per day scheduled for this.

I'm more interested in time to discharge. 

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