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    As a state licensed life, P&C and health insurance agent; and dual SEC registered investment advisor and representative, Marcinko was Founding Dean of the fiduciary and niche focused CERTIFIED MEDICAL PLANNER® chartered professional designation education program; as well as Chief Editor of the three print format HEALTH DICTIONARY SERIES® and online Wiki Project.

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Understanding Capital Investment Risks for Hospitals

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Capital Investment Risks for Hospitals

By Calvin Weise CPA and Dr. David E. Marcinko MBA CMP®

www.CertifiedMedicalPlanner.org

Capital investments create risk. Risk is the uncertainty of future events. When hospitals make capital investments, they commit to costs that affect future periods. Those costs are known and relatively fixed. What is unknown are the benefits to be realized by those capital investments.

Capital Investments

For capital investments, risk is the certainty of future costs coupled with the uncertainty of future benefits. In some cases, while the future benefits are uncertain, there is a high degree of certainty that the benefits will exceed the costs. In these cases, risk can be very low. Risk may be better defined as the degree to which the uncertainty of unknown benefits will exceed the known and committed costs.

Capital Assets

When capital assets are purchased, both the burdens and the benefits of ownership are transferred to the owner. The burdens are primarily the costs associated with acquisition and installation. The benefits are primarily the revenues generated by operating the capital assets. Risk of ownership is created to the degree that the benefits are uncertain.

Manager Tasks

Hospital managers need to be skilled at putting hospital assets at risk. Without clear knowledge and understanding of the benefits and the burdens, hospitals can quickly find themselves at unacceptably high levels of risk. Risk must be continually assessed and evaluated in order to successfully put hospital assets at risk. Hospitals require many varied capital investments; their capital investments represent a risk portfolio. An effective combination of risky assets can often create risk that is less than the sum of the risk of each asset.

***

Hospital with paper MRs

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Modern Portfolio Theory

Of course, financial managers have know this for years as a basic principle of Modern Portfolio Theory (MPT), first introduced by Harry Markowitz, PhD, with the paper “Portfolio Selection,” which appeared in the 1952 Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton Miller, PhD, and William Sharpe, PhD, for what has become a broad theory for securities asset selection; and hospital assets may be viewed as little different.

Prior to Markowitz’s work, investors focused on assessing the rewards and risks of individual securities in constructing a portfolio.

Risk Measure

Standard advice was to identify those that offered the best opportunities for gain with the least risk and then construct a portfolio from them. Following this advice, a hospital administrator might conclude that a positron emission tomography (PET) scanning machine offered good risk-reward characteristics, and pursue a strategy to compile a network of them in a given geographic area. Intuitively, this would be foolish. Markowitz formalized this intuition. Detailing the mathematics of diversity, he proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios of securities, or capital assets that each individually has attractive risk-reward characteristics.

In a nutshell, just as investors should select portfolios not individual securities, so hospital administrators should select a wide spectrum of radiology services, not merely machines.

Assessment

Savvy hospital managers will mitigate ownership risk by constructing their portfolio of risky assets in a manner that lowers overall risk.

Conclusion

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FREE WHITE PAPER [Is Medical Practice a New Asset Class?] from iMBA, Inc.

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Valuing the Private Practice Physician’s Quintessential Alternative Financial Investment

Dr. DEM

By Dr. David Edward Marcinko MBA CMP

As we know, the investment industry and Modern Portfolio Theory [MPT] strives to make optimal ‘allocations’ into different ‘asset classes’; according to some defined risk tolerance level or efficient frontier.

Equities, fixed income, property, private equity, emerging markets and so, are all ‘asset classes’, into which physician investors and mutual fund or portfolio managers will make an allocation of their total funds under management. It is quite proper for them to do this as they seek to balance the risk and potential returns for their own; ME, Inc., or other clients’ money.

And, by creating a “new” asset class, this concept opens the door to significant capital flows; advisory and management fees. Hence; the unrelenting innovation of Wall Street, and its’ commission driven and fee-seeking mavens, is unending.

The Social Security Example:

This concept may be illustrated using Social Security as an example.

Wall Street opines, if you’re not counting on Social Security benefits as a part of an overall asset allocation strategy, you may be missing out on bigger gains in a retirement portfolio. Those of this ilk say that retirement investors should consider the value of their Social Security as a portion of their fixed-income investments …. Others believe it may be too risky.

***

Empty Retired Doctor's Lounge

***

The Portfolio Shift

Generally, adopting this strategy would mean shifting a big portion of investible assets out of bonds and into stocks and into the hands of money managers, stock brokers and wealth managers for a fee; of course. This is akin to those financial advisors who rightly or wrongly goaded clients to not pay off a home mortgage and instead reposition the free cash flow into a rising; and then falling; market. Of course, there are detractors, as well as proponents of this emerging financial planning philosophy.

For example, Jack Bogle, founder of the Vanguard Group, often cites his penchant for basing one’s asset allocation on age. (If you’re 40 years old, you have 40% of your investments in fixed income and 60% in equities. By the time you’re 60, you’ve got 60% in fixed income, 40% in equities).

Now, let’s again consider Social Security, citing a physician with $300,000 in an investment portfolio, and capitalizing the stream of future payments. If the $300,000 is all in equity funds, even equity-index funds, and $300,000 in Social Security, you are already at 50/50″ fixed income versus equities.

The next step is a conversation as this the nexus of where Social Security meets risk management. So, how will the doctor feel when market goes up and down? Some may believe the concept, but not enjoy the inevitable more fluctuating self-directed 401-k, or 403-b plan. One must be comfortable with taking on a larger stock position.

Sources:

  • Andrea Coombes; MarketWatch, September, 2013.

Others experts, like Paul Merriman, opine that Social Security is not an asset class and the idea is fundamentally flawed and should not be a part of anyone’s portfolio.

***

Physician SGR Critics and the Doctor Fix

***

Why?

As classically defined, a portfolio is composed of financial assets. A financial asset is something that can be sold. Social Security cannot be bought and sold. Because of that, it has a market value of zero.

Therefore, since a medical practice can be bought or sold, the definitional decision is left up to the informed reader, modern physician or financially enlightened financial advisor; or Certified Medical Planner.

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What is Tactical Portfolio Management?

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Re-Thinking Strategic Allocation

[By Dr. David Edward Marcinko MBA]

Dr. David E. Marcinko MBAMany successful physician investors, retirement account managers or endowment fund administrators will establish a “strategic” allocation policy that is intended to guide long-term (greater than one-year) investment decisions.

Thinking Long Term?

This strategic allocation reflects the endowment’s thinking regarding the existence of perceived fundamental shifts in the market. Most endowments will also establish a target range or band for each asset class. The day-to-day managers then have the flexibility to make tactical decisions for a given class so long as they stay within the target range.

Terms

The term “tactical” when used in the context of investment strategy refers to the investor or manager’s ability to take advantage of short-term (under one year) market anomalies such as pricing discrepancies between different sectors or across different styles.

Assessment

Historically, tactical decisions with respect to asset allocation were derided as “market timing.” However, market timing implies moving outside of the target ranges whereas tactical decision making simply addresses the opportunistic deployment of funds within the asset class target range.

So, what do you think?

Online MD investor

Conclusion

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Are We Over-Optimizing Portfolio Asset Classes?

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Too Many Other Asset Classes?

[By Dr. David Edward Marcinko MBA CMP™]Dr. David E. Marcinko MBA

Some financial analysts believe that the focus on asset classes may have gone too far as physicians and other investors have sought to “over optimize” their portfolios.

In fact, colleague David Loeper, CEO of Wealthcare Capital Management, explained this concept as follows:

“Where things have really got off track has been the insistence on breaking asset classes into sub-classes by style, market capitalization, etc. The unpredictability of all the inputs into our optimizers, even over long periods of time, has been ignored. We have attempted to take efficient portfolios of stocks, bonds and cash and make them even more efficient by breaking the unpredictable asset classes into even less predictable sub-classes. This has all been done into the pursuit of “efficiency” as the proposal was validated by the Brinson & Beebower study, which purports to find that over 90% of the investment return variance is explained by asset allocation. The risk that you produce inefficient portfolios INCREASES if you increase the number of “asset classes” for which you must forecast not only the risk and returns but also each asset class’ correlation to the others.”

Assessment

If true, and I think it is a valid point, the results of the optimizer and your resulting portfolio’s efficiency is based on the accuracy of the inputs and NOT THE NUMBER OF THE INPUTS.

Stock_Market

Or, is this like the TNTC situation in cell cultures and microbiology [Too Numerous To Count].Certified Medical Planner  Conclusion

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Do Physician Investors and/or their Financial Advisors Use and Abuse Modern Portfolio Theory?

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The Cultural Clash of Passivity versus Activity

By Dr. David Edward Marcinko MBA CMP™

www.CertifiedMedicalPlanner.org

[Publisher-in-Chief]

Ninety-three year old Professor Harry Markowitz PhD, coined the phrase “modern portfolio theory” [MPT] and concluded that investors are rewarded for taking certain risks but may not get rewarded for taking others. He developed the notion of an “efficient frontier” for different groups of asset classes and the idea that the higher the expected return, the higher the risk.

The Biblical Brinson, Hood, Beebower Study

In their 1986 study, Brinson, Hood, and Beebower attempted to measure three investment activities: (1) asset class selection, (2) market timing, and (3) security selection. They concluded that asset class selection had, by far, the greatest effect on the risk/return characteristics of a portfolio (some 93.6% of performance). But the most startling conclusion was that, if left alone, investment policy would have produced a higher average return than when market timing and security selection were taken into account. These latter factors actually reduced the average return over a 10-year period.

The Fama & French Study

In 1982, Fama and French found that three factors—market exposure, company size, and “value”—were systematic risks that explained the vast majority of equity market returns. “U.S. small-cap value stocks” is therefore a discreet asset class possessing all three of these systematic risks.

Most physicians and financial advisors are aware of modern portfolio theory but some fail to apply the principles to actual investor situations. Three examples: (1) using erroneous asset-class definitions, (2) using actively managed funds, and (3) relying on market timing. The abuse of modern portfolio theory can create portfolios loaded with latent risks that, on the surface, appear benign.

Not all Agree

Not everyone is in agreement with modern portfolio theory. Some detractors agree in principle, recognizing, for example, that “value” stocks have had higher returns than “growth” issues but they cite the cause as “mispricing” rather than risk.

Assessment

Institutional investors have gradually increased their commitment to passive strategies from virtually zero 20 years ago to 30% or more in the last decade [Think: Vanguard].

Individual and physician investors, on the other hand, have less than a 5% commitment.

Note: “Modern Portfolio Theory: Fact or Fiction?,” Gerard F. Stellwagen and Robin P. LaCouture, NAPFA Advisor, July 1997, pp. 1–7, National Association of Personal Financial Advisors for Fee-Only Financial Advisors.

Conclusion

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The Living Legacy of Dr. Harry Markowitz

Creating Diversified Portfolios of Uncorrelated Assets

By Dr. David Edward Marcinko MBA CMP™

[Publisher-in-Chief]

More than a half century ago, a paper appeared in The Journal of Finance written by a 24-year-old doctoral candidate in economics at the University of Chicago—Harry Markowitz. It was called “Portfolio Selection” and suggested that investors take into account risk in pursuit of the highest return—a concept that we take for granted today [Modern Portfolio Theory].

Markowitz drew a trade-off curve between risk and reward and called it the “efficient frontier.” A rational physician executive or other investor who knew his or her risk tolerance could choose an appropriate portfolio from a point on this curve. Markowitz led investors to diversified portfolios of uncorrelated investments.

Dissertation Follow-up

Markowitz followed up his dissertation in 1959 with a book entitled Portfolio Selection [Efficient Diversification of Investment]. His many contributions to finance earned him the Nobel Prize in Economic Science in 1990 along with William Sharpe and Merton Miller. He reasoned that diversification is about avoiding the covariance.

If risks are uncorrelated, you can reduce the risk of a portfolio to practically zero by sufficient diversification. This doesn’t work if risks are correlated. If one invests in a very large number of securities that are correlated, risk does not approach zero but rather the average covariance, which is a very substantial amount of risk.

Where It All Started

It was at the RAND Corporation that Markowitz met William [Bill] Sharpe who was working on his PhD at UCLA. Markowitz takes issue with Sharpe’s Capital Asset Pricing Model (CAPM), which claims that the expected return of a security depends only on its beta—ignoring fundamental analysis.

CAPM also implies that the market portfolio is efficient, even though investors in the market may not act rationally. It says that the market portfolio is a mean-variance efficient portfolio. Markowitz disputes this conclusion. He points to Fama and French and others who have found that expected returns are more closely related to book-to-price or size—not to beta.

hm

Assessment

The still living Markowitz fends off criticism of mean-variance analysis only being valid when probability distributions are normal by stating that he realizes that probability distributions are not normal in the real world.

But, if they are similar to a normal distribution, mean variance does a good job at approximating expected utility. He admits that when they are too dispersed, mean variance doesn’t work well.

Note: Travels along the Efficient Frontier,” an interview with Harry Markowitz by Jonathan Burton, Dow Jones Asset Management, May/June 1997, pp. 21–28, Dow Jones Financial Publishing Corp.

Conclusion

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Is There an “Efficient Frontier” for Medicare Payment Reform?

An Essay on Financial Health Risk Self-Selection

By Dr. David Edward Marcinko MBA CMP™

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[Publisher-in-Chief]

Health economist Austin Frakt PhD, of the Incidental Economist, alerted us to this recent publication “Achieving Cost Control, Care Coordination, and Quality Improvement through Incremental Payment System Reform”, by and from: (Averill, et al., JACM, 2010). The paper describes various Medicare payment reform methods.

The Abstract

The healthcare reform goal of increasing eligibility and coverage cannot be realized without simultaneously achieving control over healthcare costs. The reform of existing payment systems can provide the financial incentive for providers to deliver care in a more coordinated and efficient manner with minimal changes to existing payer and provider infrastructure. Pay for performance, best practice pricing, price discounting, alignment of incentives, the medical home, payment by episodes, and provider performance reports are a set of payment reforms that can result in lower costs, better coordination of care, improved quality of care, and increased consumer involvement. These reforms can produce immediate Medicare annual savings of $10 billion and create the framework for future savings by establishing financial incentives for long-term provider behavior changes that can lead to lower costs.

Patient Risk Sharing

Of course, the third dimension of risk [beyond traditional doctor/hospital provider and Medicare insurer] would be the risk borne by the patient insured (degree of cost-sharing or “consumer responsibility”). This relationship is represented diagrammatically right here:

Brief Review of MPT

Modern portfolio theory (MPT) attempts to maximize investment portfolio expected returns for a given level of risk by carefully choosing the proportions of various asset classes. As a mathematical formulation, the concept of diversification aims to select a collection of assets that collectively lowers risk [measured by standard deviation] more than any individual asset class. This pleasing point is known as the “efficient frontier.” And, it can be seen intuitively because different types of assets often change in value in opposite ways.

Is There an Insurance Efficient Frontier?

Health insurance [medical payment reform] econometric considerations may now be extended in this analogy to suggest that medical providers and CMS payers are the surrogates for two dimensions in the MPT. The third might be the risks borne by the patient insured (degree of cost-sharing or “consumer responsibility”), as above.

Assessment

Then, patients could self-select where they wish to fall on the health insurance “efficient frontier”, balancing all three dimensions as in MPT, along with lifestyle and moral hazard considerations, etc.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. Is there an “efficient frontier” for Medicare payment reform?

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