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Health Care Provider ETF In Focus On M&A Talks

The merger mania is not showing any sign of slowdown in the health care space. Now, health care insurers, which are facing the double whammy of margin erosion and increased regulatory oversight due to Health Care Reform Act or Obamacare, have stepped up consolidation activities. In fact, the five big managed health care insurers are seeking a series of potential mega-mergers that could change the landscape of the whole managed care industry. M&A Talks in Focus Health insurers – UnitedHealth Group (NYSE: UNH ), Anthem (NYSE: ANTM ), Aetna (NYSE: AET ), Humana (NYSE: HUM ) and Cigna Corp (NYSE: CI ) – have been in some kind of merger talks with each other over the last couple of weeks. The coldest match-up war is between Aetna-Humana and Aetna-UnitedHealth. This is especially true as Aetna made a takeover proposal to Humana last weekend, as per the Wall Street Journal, while on the other hand, UnitedHealth made a preliminary takeover approach to Aetna last week. Meanwhile, Anthem renewed a sweetened offer to acquire Cigna for $54 billion, including debt. The deal includes $184 per share in cash and stock. About 31% would be paid in Anthem shares, which represents 29% premium to Cigna’s average closing price in the past 20 trading sessions, and the rest in cash. The combination could be the industry’s biggest takeover in history and could make Anthem bigger than the industry leader UnitedHealth – and thus the largest U.S. insurer in terms of membership. However, Cigna rejected the proposal citing the bid as “inadequate” and not in the best interests of its shareholders. Both companies have been in talks for months and the latest bid is the second in the last 10 days. The mergers – if these come through – could dampen competition in the managed care industry leading to heavy concentration in the hands of a few. This is because a merger could shrink the top insurers names from five to just three with revenues of over $100 billion each. However, it could enhance operational efficiencies with more revenue opportunities from Obamacare and privatization of Medicare and Medicaid at an adequate margin and return on capital. Given the series of M&A talks in the health insurer corner of the broad health care space, the iShares U.S. Healthcare Providers ETF (NYSEARCA: IHF ) could be worth a look for investors seeking to ride out the surge on the merger wave. IHF in Focus This ETF follows the Dow Jones U.S. Select Healthcare Providers Index with exposure to companies that provide health insurance, diagnostics and specialized treatment. In total, the fund holds 51 securities in its basket. UnitedHealth takes the top spot in the basket with 11.98% share while the other in-focus four firms – AET, ANTM, CI and HUM – are also among the top 10 holdings making up for a combined 24.2% of assets. The fund has amassed $958.6 million in its asset base while volume is moderate at about 81,000 shares per day on average. It charges 43 bps in annual fees from investors and added 4.9% over the past couple of weeks. The product has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a Medium risk outlook. Originally published on Zacks.com

Is GREK Today’s Least Competitive Wealth-Builder ETF Investment?

Summary Days ago our article identified an ETF ranked at the best end of the scale posed in the title above, drawing Seeking Alpha reader attention. The ongoing EU vs. Greece drama now reaching a moment of (possible) truth has as one (or more) possible outcome(s) capable of defining an immediate tragedy. Hence the question being raised. And if this is not the worst possible choice of a long ETF position, is (are) there more threatening one(s)? Market-makers have to appraise them all, to do their jobs. We use their hedging actions to tell us what they think. It’s beyond our ken. Way beyond. Value analysis requires comparisons. Without appraisal of the bad, how do we know good? Yin and Yang are both essential. How does GREK look to market-makers? The Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) presents market-makers with a challenging task of appraisal. In our recent article we posed the question this way: From a population of some 350 actively-traded, substantial, and growing ETFs is this a currently attractive addition to a portfolio whose principal objective is wealth accumulation by active investing? We daily evaluate future near-term price gain prospects for quality, market-seasoned ETFs, based on the expectations of market-makers [MMs], drawing on their insights from client order-flows. Following that article’s format where possible, let’s look at their appraisal of GREK. Yahoo describes it this way: The fund currently holds assets of $310 million and has had a YTD price return of -9.1%. Its average daily trading volume of 899,906 produces a complete asset turnover calculation in 29 days at its current price of $11.77. (The Bank of Piraeus may wish it had as long on withdrawals.) Behavioral analysis of market-maker hedging actions while providing market liquidity for volume block trades in the ETF by interested major investment funds has produced the recent past (6 month) daily history of implied price range forecasts pictured in Figure 1. Figure 1 (used with permission) The vertical lines of Figure 1 are a visual history of forward-looking expectations of coming prices for the subject ETF. They are NOT a backward-in-time look at actual daily price ranges, but the heavy dot in each range is the ending market quote of the day the forecast was made. What is important in the picture is the balance of upside prospects in comparison to downside concerns. That ratio is expressed in the Range Index [RI], whose number tells what percentage of the whole range lies below the then current price. Today’s Range Index is used to evaluate how well prior forecasts of similar RIs for this ETF have previously worked out. The size of that historic sample is given near the right-hand end of the data line below the picture. The current RI’s size in relation to all available RIs of the past 5 years is indicated in the small blue thumbnail distribution at the bottom of Figure 1. The first items in the data line are current information: The current high and low of the forecast range, and the percent change from the market quote to the top of the range, as a sell target. The Range Index is of the current forecast. Other items of data are all derived from the history of prior forecasts. They stem from applying a T ime- E fficient R isk M anagement D iscipline to hypothetical holdings initiated by the MM forecasts. That discipline requires a next-day closing price cost position be held no longer than 63 market days (3 months) unless first encountered by a market close equal to or above the sell target. The net payoffs are the cumulative average simple percent gains of all such forecast positions, including losses. Days held are average market rather than calendar days held in the sample positions. Drawdown exposure indicates the typical worst-case price experience during those holding periods. Win odds tells what percentage proportion of the sample recovered from the drawdowns to produce a gain. The cred(ibility) ratio compares the sell target prospect with the historic net payoff experiences. Figure 2 provides a longer-time perspective by drawing a once-a week look from the Figure 1 source forecasts, back over (almost) two years. Figure 2 (used with permission) What does this ETF hold, causing such price expectations? Figure 3 is a table of securities held by the subject ETF, indicating its concentration in the top ten largest holdings, and their percentage of the ETF’s total value. Figure 3 (click to enlarge) Well, maybe that’s what is causing such price expectations, but it seems more likely that international politics has more to do with it. So let’s depart from GRKZF, the Greek Organization of Football Prognostics SA, and turn to the Wall Street organization of stock price prognostics, or market-makers [MMs]. Sport is where you find it. Just how bad is the GREK outlook? We use the MMs forecasts for stock and ETF prices, implied by their self-protective hedging actions, plus the accumulated actuarial history of market price events following such prior forecasts as are seen today, to rank each subject. Figure 4 is a table of how the worst-ranking ten ETFs appear. Please remember, our ranking interest is in wealth-building, not wealth destruction. What works well in one direction may not work in the opposite. Shorting is not recommended. Figure 4 (click to enlarge) When we compare the wealth-building prospects for GREK (ranked 270th out of 340) it doesn’t come close to the terrors inherent in these last ten. Remember, the MMs role is to build a balance between buyers and sellers in every trade, so they have to find acceptable expectations at each end of an actionable array of prices. The actions produce the trade, the expectations are what produce the actions. Check the row of data beneath the top illustration of Figure 1. Its forecast upper end is 23.7% above the then-current price of $10.58. That compares to the ten-ETF average of Figure 4 of +29.4% in column (5). What of the risk exposure? When GREK in the past has been seen by MMs to have an outlook like today’s (a Range Index of 33, meaning twice as much upside as downside) its typical worst-case price drawdown experienced was but -16.3%. The worst-ten ETFs of Figure 4 managed -19.7% — a fifth of their capital gone, not just less than a sixth. And on top of that GREK had 42 out of 100 chances of seeing its price recover back into profit territory, while those other ETFs had but one chance in four of that happening (column 8 blue average). And they started, on average, from prior forecasts with Range Indexes of 26, with three times as much upside as down. See? GREK could be worse. ‘Course it could (needs to) be better. The average equity today offers a 29 Range Index with +12.5% upside. There is real credibility to that population forecast, since prior similar forecast hypothetical positions produced gains of +3.9% (net of 35/100 losses, not 58/100). GREK actually had prior net losses of -6.5% and negative credibility ratio (like the other worst ten ETFs) comparing upside forecasts to actual TERMD payoffs. Conclusion But those are historical comparisons. The past may not be prologue. Buyers must hope so. Besides, there is less than two years of GREK pricing for us to work with. Maybe Greece has just had a bad recent two years. We keep a ten-foot long pole at hand for just such occasions. Hope we don’t have to use it, not sure we would. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Drivers Of ROE In The Context Of Portfolio Management

Someone on the Corner of Berkshire and Fairfax message board recently posted this comment referencing Buffett’s well-known piece on inflation from 1977 . In the article, Buffett describes the variables that drive a company’s return on equity. There are only five ways that a company can improve returns: Increase turnover Cheaper leverage (reduce interest charges) More leverage (increase the amount of assets relative to a given level of equity) Lower income taxes Wider margins Notice three of the five drivers of ROE have to do with taxes and leverage. So the pretax returns (as opposed to capital structure variations) are really driven by just asset turnover and profit margins. Some executives at the DuPont Corporation (NYSE: DD ) also noticed these drivers in the 1920s when analyzing their company’s financial performance. They broadly categorized the drivers as turnover, margins, and leverage. For now, I want to leave leverage out of it and think about turnover and margins. Portfolio Turnover I wrote a post a while back discussing the misunderstood concept of turnover in the context of portfolio management. Specifically, the topic of realizing gains (and paying those dreaded taxes). Basically, the idea of short-term capital gains is taboo among many value investors. I think it’s very important to try and be as efficient as possible with taxes. However, I think that tax consideration is only one of the (not the only) factors to consider. We could take Buffett’s five inputs that increase or decrease a company’s ROE and apply them to the portfolio. Basically, as investors, we are running our portfolio just like a business . We have a certain level of equity in the portfolio, and we are trying to achieve a high return on that equity over time. The exact same factors that Buffett talks about above apply to our portfolio. Those five factors are the inputs that will increase or decrease our portfolio ROE (aka CAGR) over time. Notice that taxes is one of the (but not the only) factors. Turnover is also one of the (but not the only) factors. Michael Masters is not a value investor, but he runs a fund that has produced fabulous returns over the past 20 years or so (from what I’ve read, north of 40% annually). You can read about him in the book Stock Market Wizards by Jack Schwager . Now, I don’t understand his specific strategy, and I’m not suggesting it’s one that should be cloned, or copied, etc… I’m just focusing on the turnover concept here. Masters, according to the interview, runs a strategy focused on fundamental catalysts, and holds stocks an average of 2-4 weeks. When he was running a smaller amount of money, he was compounding at 80%+ per year. Of course, he was paying a lot of taxes. His investors – the ones in the highest tax bracket – might be “only” netting 40% or so after tax. But who would be upset with paying a lot of taxes if it means achieving a 40% return on the equity in your capital account? Obviously an extreme example, but the concept illustrates the point that just because you hold stocks for years and years and pay very low taxes doesn’t mean that your after tax ROE will be any better than an investor who pays a lot of tax and achieves a much higher pretax return. I think it’s very difficult to compound capital at 20% or more without some amount of turnover in the portfolio. This doesn’t mean I’m promoting higher levels of activity. I’m not. I think making fewer decisions is often better, and trying to do too many things is very often counterproductive. I’m just saying that the math suggests that some level of turnover is needed if your goal is to compound capital at north of 20% over time. This is one of the reasons I love bargains and deep value special situations in addition to the compounders. As I’ve said before, very few companies compound their equity and earnings at 20% or more over years and years. Those that do often are priced expensively in the market. But to achieve portfolio returns of 20% without paying taxes, you’d have to not only properly identify these companies in advance, but you’d have to have the foresight to invest your entire portfolio in them. How Did Buffett and Munger Achieve Their Results? It’s a difficult proposition to be able to seek out in advance the truly great compounders that will compound at 20%+ for a decade or more, and that’s why investors who focus on bargains and special situations often are the ones with the extreme performance numbers (like Buffett doing 50% annual returns in the 50s, Greenblatt doing 40% annual returns in the 80s and 90s, etc…). It’s unlikely to do 20% annual returns by buying and holding great businesses for a decade without selling. It’s basically impossible to do 30%+ without ever selling. Charlie Munger has promoted the idea of low turnover – and I think his reasoning (as usual) is very sound, but I think he was using the Washington Post as an example – and I think that might be (dare I say) somewhat biased in hindsight. But if you’re looking for decent after tax returns, he’s right. If you can find a company that compounds at 13% per year for 30 years, you’re going to achieve good after tax returns on your capital. But, I think finding the Washington Posts of the world are easier said than done in hindsight, especially when thinking about a 30-year time horizon. Another example I’ve discussed before is Disney (NYSE: DIS ). Buffett bought Disney for $0.31 per share and sold a year later for a 50% gain in the mid-60s. He laments that decision as a poor one, but in fact his equity has compounded at a faster rate than Disney’s stock over time, making his decision to sell out for $0.50 a good one. And that is an extreme example using probably one of the top 10 compounders of all time. Not every stock is a Disney, thus making the decision to sell at fair value after a big gain in a year or two much more likely to be the correct one. Back to Munger’s Washington Post example… I like to consider his audience. I don’t necessarily think he was saying this is the highest way to achieve attractive investment results. My guess is he was trying to convey the importance of long-term thinking and lower turnover. However, when Munger ran his partnership, he was trying to compound at very high rates, and for years did 30% annual returns. He didn’t do this by buying and socking away companies like the Washington Post. He may have had a few ideas like that, but he was a concentrated special situation investor who was willing to look at all kinds of mispriced ideas. Buffett/Munger of Old vs. New I think there is a disconnect between the Buffett/Munger of old, and the Buffett/Munger of today. Their strategies have obviously changed, and their thinking has evolved. But their best returns were in the early years when they could take advantage of the (often irrational) pricing that Mr. Market offered. They were partners with the often moody Mr. Market back then and they took advantage of his mood swings. When they came into the office and Mr. Market was downtrodden, they’d buy from him. And on the days when Mr. Market was excited and overly optimistic, they’d sell to him. Their bargain hunting days provided them and their investors with 20-30% annual returns. They made a lot of money. They paid a lot of taxes. As they compounded capital, they began to evolve. Buffett and Munger both have discussed this, but they both have said with smaller amounts of capital, they’d invest very differently. Buffett bought baskets of Korean stocks in his personal account in 2005 when some were trading at 2 times earnings with net cash on the balance sheet. He’s also done arbitrage situations, REIT conversions, and other things in his personal account that provided attractive, low-risk returns (and very high annualized CAGRs). By the way, this is not an indictment against compounders. As I’ve mentioned before, my investments tend to fall into one of two broad categories: compounders and special situations/bargains. I actually enjoy investing in compounders the most, since they do the work for you. But bargains are the ones that often get more glaringly mispriced for a variety of reasons (not the least of which is the fact that the compounders are great businesses – and everyone knows they are great). But I don’t have a dogmatic approach to investing, and I will look for value wherever I can find it. I’m not sure if this post really has a hard conclusion and maybe this is more of a ramble than anything else. I’m not sure how to sum it up, so I’ll just stop here. These are just observations I have had, and the COBF post on Buffett’s 1977 piece ( which is a great piece to read if you haven’t ) prompted some of these thoughts which I decided to write down and share. I think it’s important to understand the drivers of investment results (portfolio returns on equity) are the exact same factors that drive the ROE of a business. Feel free to add to the discussion if you’d like. Have a great week, and for the golf fans, enjoy the US Open.