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Medical “Goodwill” – Does it Still Exist?

What is the Medical Practice Goodwill Conundrum?

By Dr. David Edward Marcinko; MBA, CMP™

By Hope Rachel Hetico; RN, MHA, CMP™ 

biz-book6 In the context of long-term compensation for a lifetime of work, mature medical practitioners of all types often erroneously focus on the intangible of “goodwill” upon retirement; especially relative to medical practice worth.    

Definition

Goodwill is defined as “The ability of a business to generate income in excess of a normal rate on assets due to superior managerial skills, market position, new product technology, etc.  In the purchase of a business, goodwill represents the difference between the purchase price and the value of the net assets.” 

Yet, there are two types of goodwill, with one far more compensable than the other.  

Physician Goodwill  

Personal goodwill results from the charisma and reputation of a specific doctor. Its attributes accrue solely to the individual, are not transferable and can’t be sold. They have no economic value. Nevertheless, young uninformed physicians may over-compensate retiring doctors for this non-existent “asset.” 

Business Goodwill

Medical practice entity goodwill, on the other hand, may be transferred and is defined as the unidentified residual attributes that contribute to the propensity of patients and managed care contracts (and their revenue streams) to return in the future (Schilbach v. Commissioner, T.C. Memo 1991-556).  

However, one must appreciate the: (i) impact of a changing environment; (ii) practice transfer activity in a local market which can augment or blunt goodwill value; and the (iii) determination of whether patients or HMOs return because of goodwill or are mandated by contractual obligations.

A good medical practice is not necessarily a good business, and retiring group practice doctors can no longer extract excess compensation for this intangible asset.

Moreover, astute younger physicians should not over-pay for it, either.

So, what is your economic experience in the matter; as an emerging, mature or retiring physician?

Speaker: If you need a moderator or a speaker for an upcoming event, Dr. David Edward Marcinko; MBA is available for speaking engagements. Contact him at: MarcinkoAdvisors@msn.com  

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When to Change Money Managers?

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The Money Managers

By Clifton N. McIntire, Jr.; CIMA, CFP®

By Lisa Ellen McIntire; CIMA, CFP®

Sometimes even the best made plans just don’t work out. Despite extensive time and energy spent on due diligence before hiring an investment manager, it becomes evident that the doctor must change managers. 

Here are a few thoughts when considering a change:

 § You should have initially hired the manager with a long-term relationship in mind. Realizing that styles go in and out of favor, we were not simply buying last quarter’s best numbers. 

§ Market statistics often mask “real” performance of money managers, both good and bad. The S&P 500’s 1998 performance can be attributed to a few very large companies. 

§ Generally, a full market cycle would be required to assess money manager performance. 

Having said that, what could happen that would warrant changing managers? 

· Style Drift: You have a growth manager and when growth stocks turn down, you begin to see the purchase of “value” stocks.

· Not Sticking to Previously Established Disciplines: If the process is to sell if the price declines 20 percent down from the original buy range and now they are holding because, “This time, it is different.” 

· Personnel Changes: New analysts are hired with a different philosophy. Recent transactions seem 180 degrees off course.

·  Principals Leave: Like professional sports figures, good money managers are in demand and sometimes change firms. The replacement may be a 27-year-old MBA with little experience. 

· The Firm is Sold: This may be good new if it broadens ownership and helps retain good people. Look for long-term incentive driven “staying” bonus plans.

· Loss of Major Accounts:  Reduced revenues may force cut backs in personnel and services. Attention may shift from portfolio management to marketing.

Finally, sometimes the relationaship is just not working. Misjudgments in asset allocation and poor stock selection over a reasonable period of time can be reason enough for a doctor to change managers.

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Assessment

Do you use a money manager or self direct your own portfolio? Have you ever needed to change you money manger? 

Conclusion

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Guide to Risk-Adjusted Market Performance

What isn’t Measured – Isn’t Improved

By Jeffrey S. Coons; PhD, CFA

By Christopher J. Cummings; CFA, CFP™ 

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Market performance measurement, like physician quality improvement reports, is an important feedback loop to monitor progress towards the goals of the medical professional’s investment program. 

Performance comparisons to market indices and/or peer groups are a useful part of this feedback loop, as long as they are considered in the context of the market environment and with the limitations of market index and manager database construction. 

Introduction

Inherent to performance comparisons is the reality that portfolios taking greater risk will tend to out-perform less risky investments during bullish phases of a market cycle, but are also more likely to under-perform during the bearish phase.  The reason for focusing on performance comparisons over a full market cycle is that the phases biasing results in favor of higher risk approaches can be balanced with less favorable environments for aggressive approaches to lessen/eliminate those biases. 

Can we eliminate the biases of the market environment by adjusting performance for the risk assumed by the portfolio?  While several interesting calculations have been developed to measure risk-adjusted performance, the unfortunate answer is that the biases of the market environment still tend to have an impact even after adjusting returns for various measures of risk. 

However, medical professionals and their advisors will have many different risk-adjusted return statistics presented to them, so understanding the Sharpe ratio, Treynor ratio, Jensen’s measure or alpha, Morningstar star ratings, etc. and their limitations should help to improve the decisions made from the performance measurement feedback loop. 

[a] The Treynor Ratio

The Treynor ratio, named after MPT researcher Jack Treynor, identifies returns above or below the securities market line. It measures the excess return achieved over the risk free return per unit of systematic risk as identified by beta to the market portfolio.  In practice, the Treynor ratio is often calculated using the T-Bill return for the risk-free return and the S&P 500 for the market portfolio. 

[b] The Sharpe Ratio

The Sharpe ratio, named after CAPM pioneer William F. Sharpe, was originally formulated by substituting the standard deviation of portfolio returns (i.e., systematic plus unsystematic risk) in the place of beta of the Treynor ratio.  A fully diversified portfolio with no unsystematic risk will have a Sharpe ratio equal to its Treynor ratio, while a less diversified portfolio may have significantly different Sharpe and Treynor ratios. 

[c] Jensen Alpha Measure

The Jensen measure, named after CAPM research Michael C. Jensen, takes advantage of the Capital Asset Pricing Model to identify a statistically significant excess return or alpha of a diverse portfolio.   

However, if a portfolio has been able to consistently add value above the excess return expected as a result of its beta, then the alpha (ap) should be positive and (hopefully) statistically significant.

Thus, alpha from a regression of the portfolio’s returns versus the market portfolio (i.e., typically the S&P 500 in practice) is a measure of risk-adjusted performance.  

Now, how do you measure the success or failure of your portfolio?

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Money Management and Portfolio Performance

Money Management and Portfolio Performance

By Jeffrey S. Coons; PhD, CFA

By Christopher J. Cummings; CFA, CFP™ 

Evaluating portfolio performance is a vital and often contentious topic in monitoring progress towards a physician’s investment goals.   

Introduction 

A typical portfolio’s objective may be to preserve the purchasing power of its assets by achieving returns above inflation – or to have total returns adequate to satisfy an annual spending need without eroding original capital, etc.  Whatever the absolute goal for the doctor; performance numbers need to be evaluated based on an understanding of the market environment over the period being measured.

One way to put a portfolio’s a time-weighted return in the context of the overall market environment is to compare the performance to relevant alternative investment vehicles.   This can be done through comparisons to either market indices, which are board baskets of investable securities, or peer groups, which are collections of returns from managers or funds investing in a similar universe of securities with similar objectives as the portfolio.

By evaluating the performance of alternatives that were available over the period, the physician investor and/or his/her advisor are able to gain insight to the general investment environment over the time period.

The Indices 

Market indices are frequently used to gain perspective on the market environment and to evaluate how well the portfolio performed relative to that environment. 

Market indices are typically segmented into different asset classes.

Common stock market indices include the following:

· Dow Jones Industrial Average – a price-weighted index of 30 large U.S. corporations.

· Standard & Poor’s (S&P) 500 Index – a capitalization-weighted index of 500 large U.S. corporations.

· Value Line Index – an equally-weighted index of 1700 large U.S. corporations.

· Russell 2000 – a capitalization-weighted index of smaller capitalization U.S. companies.

· Wilshire 5000 – a cap weighted index of the 5000 largest U.S. corporations.

· Morgan Stanley Europe Australia, Far East (EAFE) Index – a capitalization-weighted index of the stocks traded in developed economies. 

Common bond market indices include the following:

· Lehman Brothers Government Credit Index – an index of investment grade domestic bonds excluding mortgages.

· Lehman Brothers Aggregate Index – the LBGCI plus investment grade mortgages.

· Solomon Brothers Bond Index – similar in construction to the LBAI.

· Merrill Lynch High Yield Index – an index of below investment grade bonds.

· JP Morgan Global Government Bond – an index of domestic and foreign government-issued fixed income securities.

Assessment

The selection of an appropriate market index depends on the goals of the portfolio and the universe of securities from which the portfolio was selected. 

Just as a portfolio with a short-time horizon and a primary goal of capital preservation should not be expected to perform in line with the S&P 500, a portfolio with a long-term horizon and a primary goal of capital growth should not be evaluated versus Treasury Bills.

Conclusion 

While the Dow Jones Industrial Average and S&P 500 are often quoted in the newspapers, there are clearly broader market indices available to describe the overall performance of the U.S. stock market.

Likewise, indices like the S&P 500 and Wilshire 5000 are capitalization-weighted, so their returns are generally dominated by the largest 50 of their 500 – 5000 stocks.

Fortunately, capitalization-bias does not typically affect long-term performance comparisons, but there may be periods of time in which large cap stocks out-or under-perform mid-to-small cap stocks, thus creating a bias when cap-weighted indices are used versus what is usually non-cap weighted strategies of managers or mutual funds.

Finally, the fixed income indices tend to have a bias towards intermediate-term securities versus longer-term bonds.  Therefore, a physician investor with a long-term time horizon, and therefore potentially a higher allocation to long bonds, should keep this bias in mind when evaluating performance.

How do you evaluate your portfolio?

Do you evaluate it on a risk-adjusted basis?

Are Capital Markets Efficient?

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What is the Efficient Market Hypothesis?

[By Jeffrey S. Coons; PhD, CFA]

[By Christopher J. Cummings; CFA, CFP™]fp-book1

The Efficient Market Hypothesis (EMH) states that securities are fairly priced based on information about their underlying cash flows and that physician investors should not expect to consistently outperform the market over the long-term. 

 EMH Types 

There are three distinct forms of EMH that vary by the type of information that is reflected in a security’s price:

·  Weak Form: This form holds that investors will not be able to use historical data to earn superior returns on a consistent basis.  In other words, the financial markets price securities in a manner that fully reflects all information contained in past prices.

·  Semi-Strong Form: This form asserts that security prices fully reflect all publicly available information. Therefore, investors cannot consistently earn above normal returns based solely on publicly available information, such as earnings, dividend, and sales data.

·  Strong Form: This form states that the financial markets price securities such that, all information (public and non-public) is fully reflected in the securities price; investors should not expect to earn superior returns on a consistent basis, no matter what insight or research they may bring to the table. 

While a rich literature has been established regarding to test whether EMH actually applies in any of its three forms in real world markets – probably the most difficult evidence to overcome for backers of EMH is the existence of a vibrant money management and mutual fund industry charging value-added fees for their services. 

In fact, no less than Warren Buffett has suggested that the markets are decidedly not efficient. 

Assessment

And so, while there has been a growing move towards index funds – as well as ETFs – the strength of the money management industry may reflect investor’s concern with risk management and asset allocation – as much as any view that a manager or individual can “beat the market.”   

Conclusion

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