Portfolio Manager Perspectives

Jeff Benjamin

Winners, losers emerge from health-care Rx

May 17, 2010 @ 11:37 am

By Jeff Benjamin

Health care reform is a long way from completion, but the opportunities to pick winners and losers in the sector are already here, according to Michael Gregory, manager of the Highland Long/Short Healthcare Fund Ticker:(HHCCX).

“The health care initiatives being introduced will benefit certain companies, but a lot of other companies will be asked to foot the bill and they will be the net losers,” said Mr. Gregory, who is subadvising the fund as a money manager for Cummings Bay Capital Management L.P.

Cummings Bay, a specialist in long/short health care stocks with $20 million under management, has taken over management of the fund for High Capital Management L.P., which has $24 billion under management.

Until a few weeks ago, the fund had been managed since its 2006 launch as a traditional long-only health care sector fund.

The long-only health care space, which Mr. Gregory estimates at 40 mutual funds with a combined $35 billion under management, is capturing only half of the market's potential by not going short.

“The reason for the change in the strategy is to be able to capture the full breadth of the industry,” he said. “Health care represents 16% of GDP, and it is emerging as a very defensive sector, and reform is creating a phenomenal environment to invest in both winners and losers.”

The portfolio, which has just $8 million under management, is in the midst of transition, but is designed to have a net-long bias, Mr. Gregory said.

The investment strategy divides the health care industry into five broad categories: health care services, pharmaceuticals, biotechnology, medical technology, and life sciences.

As an example of where Mr. Gregory identifies potential long and short positions, the health insurance companies are divided into three groups, including Medicaid managed-care companies, commercial insurers that provide corporate plans to employees, and Medicare for people over the age of 65.

Among those three groups, the Medicaid insurers are seen as likely winners because they will start providing insurance to a lot more people.

“That's the market that is going to grow as reform starts providing insurance to people living below certain poverty levels,” Mr. Gregory said.

Examples of pure Medicaid managed care providers include Amerigroup Corp. Ticker:(AGP), Molina Healthcare Inc. Ticker:(MOH) and WellCare Health Plans Inc. Ticker:(WCG).

Commercial and Medicare insurers will be at a disadvantage unless they can succeed in building market share in the Medicaid space.

Commercial insurers could be particularly hamstrung due to reform rules known as “minimum loss ratios” that force companies to narrow their own profit margins.

The most immediate impact of that specific rule could be drastic cuts to commissions paid to insurance brokers, Mr. Gregory said.

Some examples of commercial insurers include Aetna Inc. Ticker:(AET), Cigna Corp. Ticker:(CI), and WellPoint Inc. Ticker:(WLP).

Hospitals are an area that Mr. Gregory believes will do well because more patients should be able to pay their medical bills through insurance.

“On average, 20% of hospital bills go unpaid,” he said. “By insuring everyone, that turns non-paying customers into paying customers.”

Some examples of publicly traded hospital companies include Health Management Associates Inc. Ticker:(HMA), Tenet Healthcare Corp. Ticker:(THC), and Universal Health Services Inc. Ticker:(UHS).

“Right now the health care sector is trading at a 40% discount to the S&P 500,” Mr. Gregory said. “Reform has created a tremendous lack of visibility in health care, and yet this is the biggest structural change in health care since the enactment of Medicare and Medicaid in 1965.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.


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