December 8, 2016
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Client Question? Does value exist in the health care space given all the political talk and huge declines?
We believe opportunity always exist somewhere. Generally it is where the headlines place the most fear. Today that environment seems to center around healthcare.
Here’s my perspective, the healthcare system is a mess. It is the result of decades of poor decisions, perverse incentives, and political gridlock.
At the same time, this is the political reality we live in. Making wholesale, systemic changes is next to impossible. Hillary Clinton tried it in the early ’90s and failed so completely that it wasn’t tried again for 15 years. The Affordable Care Act only passed in 2010 because of Democratic dominance of the Presidency, House of Representatives, and (for a short time) a filibuster-proof 60-seat majority in the Senate. Even then, the law that passed was watered down, full of bad compromises and misaligned incentives. The most significant change introduced by the law was the creation of exchanges through which individuals were supposed to be able to purchase affordable, government-subsidized health insurance. However, today these exchanges appear to be on the verge of collapse, as the law didn’t include enough incentives to get healthy people to sign up (creating a severe adverse selection problem) or enough financial protections to ensure participation by private insurers.
Most importantly, the Affordable Care Act further entrenched the current system. There were some new rules created, money shifted from here to there, but the major players–hospitals, insurance companies, pharmaceutical manufacturers, PBMs, and so on–all retained their primary functions.
This leads us to the opportunity part of investing. As this mess has unfolded, the uncertainty around hospitals, insurance companies, pharmaceuticals, benefit managers, distributors has grown to a very high level. We are seeing valuations rarely seen in these industries for many historically strong companies. The valuations continue to get better as politicians from both sides use populist rhetoric to drum support.
We started the year with low client allocations to the healthcare sector. As things have declined, we worked to increase our allocation to roughly match that of the general market index. Over the coming months we will be intensifying our efforts into researching the opportunities. At surface level, it looks as if the general market has overreacted and beat down the price of many health care stocks on the back of uncertainty rather than long term fundamentals. The volatility does appear rational given the backdrop of health care program uncertainty. Our job will be to review the long-term possibilities and match with short-term opportunities for new purchases.
While the devil is often in the details, we do know a few fundamental facts that should not change. People desire to be healthy, live longer and are willing to pay something for this benefit. Demographics show the need for health care is increasing at an astounding pace as the boomer generation ages. So while the system and politics may pressure slower price increases, the volume and demand are likely to continue moving upward. Eventually the supply and demand will meet at a somewhat mutually beneficial price. 2016 and early 2017 may prove an opportunistic time for building healthcare positions. Alas, our research shall continue as we look to own great companies at a very fair price.
So, to answer the initial client question – yes, value seems to exist in the healthcare space. We must carefully measure against some real risks to identify the best way to invest but we are actively searching and trading this space.
Evergreen Wealth Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.