Helical Port Feels the Pain – 5/31 Update
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).
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.
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).