Investing in Texas Exceptionalism

In June 2023 I featured a real estate investor who had made the bull case for Texas that it enjoyed unusual tailwinds as a diversified economy with low costs and a business-friendly government. 

Ten years ago Hearst Newspapers columnist Erica Grieder wrote a whole book with this thesis Big, Hot, Cheap, and Right: What America Can Learn From The Strange Genius of Texas

If you agree with this perspective, you now have a way to express this bet with your own money through a single exchange-traded fund, or ETF. 

The central thesis of the new ETF (ticker TXS) launched in July 2023 by sponsor Texas Capital Bank, is that “companies headquartered in Texas enjoy certain economic, regulatory, taxation, workforce and other benefits relative to companies headquartered in other states,” according to the prospectus.

Ed Rosenberg, Managing Director for ETFs and funds management at Texas Capital Bank put it to me this way: ““The Texas economy is growing faster than the rest of the country. You have a lot of companies moving here, for obvious business reasons. It’s cheaper, and it has a better tax situation. There is a lot of young talent. A lot of people want to live in the state. Texas has more Fortune 500 companies headquartered here than any other state.”

You can imagine this kind of message appeals to state leadership. In fact Governor Abbott has been doing yeoman’s work to tout this new ETF, and even celebrated it by ringing the closing bell at the New York Stock Exchange on September 29th, along with executives from Texas Capital Bank. 

How should we evaluate this fund on its merits?

In order of priority, in evaluating a potential investment mutual fund or ETF, I would look at effective diversification within its theme, fund cost, tax-sensitivity and lastly, a track record of returns. 

Diversification

The managers of TXS have paid outside data firm Syntax to create a unique index with two layers to it. The first layer is built on data from the US Bureau of Economic Analysis, which measures the GDP of Texas to figure out which industries contribute to the economy, in what proportions.

Syntax then seeks to match the industry weightings of the fund to the relative influence of different sectors on the Texas economy. The managers identified eleven separate industries that make up the Texas economy.  Energy is the largest component, but is still less than 25 percent of the index. Meanwhile consumer discretionary, industrials, and information technology make up 14.5, 12.7, and 11.5 percent of the Texas economy respectively, and therefore make up that much of the index on which TXS is built. From there, the index qualifies companies within each sector, and weights them according to market capitalization, which just means their size. 

As of September 29th, the top ten largest holdings comprised 35 percent of the fund, including well-known Texas-based companies such as Tesla, Exxon, Charles Schwab and Waste Management. So there is some significant concentration with giant companies headquartered in Texas. 

Further criteria for inclusion: Companies have to be headquartered in Texas, and meet liquidity and publicly-traded size characteristics. No penny stocks here, or closely held companies with a tiny “float,” of shares that barely trade. Overall the ETF owns more than 200 companies in eleven separate GDP-weighted industries, so certainly passes the diversification test. 

TXS_ETF
Digging into the TXS details versus benchmark

Something that the fund by definition does not offer is geographic diversification, but rather the opposite, geographic concentration. An investor would need to achieve geographic diversification with some other vehicle.

Style

One thing we can say about TXS, relative to the mid-cap index against which it is judged, is that the Texas companies in the index overall skew more toward a “value” orientation rather than a “growth” orientation. This is reflected in the dividend yield (higher than the index), in the price/earnings ratio (lower than the index) and the fact that energy rather than technology is the largest industry within the fund. That doesn’t predict returns in the future, but it is a set of characteristics that would help an investor or investment advisor figure out how TXS could interact with other investments within a larger portfolio.

Costs

TXS charges a 0.49% management fee. Management fees for mutual funds and ETFs have come down dramatically over the past two decades. If a standard mutual fund would have cost around 1 percent in fees in 1993 or 2003, the competition from low-cost index funds has made a 1 percent mutual fund or ETF an outlier today. Many passive ETFs charge 0.03 percent or 0.1 percent these days, one-thirtieth or one-tenth of what might have been standard two decades ago. To choose a higher cost ETF in 2023 is to make the implied bet that the higher-cost fund will consistently outperform its benchmark, every year. That rarely happens, so it’s rarely worth doing. TXS at one-half of one percent is somewhat expensive for an ETF. You’d expect it to earn half of one percent higher than comparable funds every year to justify the costs.

I’d grade TXS with a solid B in terms of cost. It’s not 1 percent pricey, but there are many cheaper ETFs in the marketplace.

Tax 

Tax sensitivity matters only for funds held outside of a tax-deferred retirement account. A “tax-sensitive” fund refers to the idea that high-turnover funds may generate capital gains tax liability throughout the year that a low-turnover fund does not. In general, tax sensitivity would favor passively-managed investments over actively-managed investments, and a long-term buy-and-hold approach instead of a short-term tactical approach. 

TXS describes itself as passively managed, so should end up fine on a tax sensitivity measurement. The portfolio manager also has discretion to manage securities to minimize taxes, according to Rosenberg.

Expected Returns 

TXS first became available in July 2023, so past performance measurement in October 2023 is meaningless. I mention this mostly to make the point that short-term returns should be a pretty low priority when picking this, or any other, fund. 

A rookie mistake in purchasing ETFs and mutual funds is to choose the best performing recent fund over the past 1 or 3, or even 5 years. Not only is that time horizon too short to give meaningful information, but that approach puts the investor at risk of buying hot funds, just as the market or investment fashion takes a turn in a different direction.  

Any outperformance of the fund versus its benchmark may be attributed to the initial thesis of the fund over the longest period of time. Or, it could be attributable to other factors that will be mostly understood in retrospect. In any case, judging returns of a fund in a time period less than 10 years is to risk conflating noise and signal. 

We might have some useful data 10 years from now to judge whether the “Texas Thesis” of 2023 was a good one or not. But we definitely don’t have enough data now to make that judgment. So investing in TXS can only be based on a hunch and a gamble. I’m not knocking gambles. Lots of investing is done this way. I just think it’s useful to acknowledge that we’re doing that.

I do not personally own TXS in my portfolio, at least for now. (Your daily reminder: super-low cost, super-diversified equity index funds all the way, baby!). For similar life-philosophy and personality reasons I also don’t drive a King Ranch Ford F-150. For investors who don’t mind paying a little extra and who believe in the exceptionalism of Texas, Texas Capital Bank has invented a clever way to put your money where your cowboy boots are.

A version of this post ran in the San Antonio Express-News and Houston Chronicle.

Please see related post:

Book Review: Big Hot Cheap and Right, by Erica Grieder

Post read (17) times.

Ask An Ex-Banker: Tax Loss Harvesting

Q. We have a number of investments through Vanguard – small, mid and large cap, some real estate and bonds. All have low costs. Our advisor (from another provider) recently suggested we rebalance, moving some small and mid-cap to large-cap funds. She said we should do this via “loss harvesting.”  I have tried to read up and look at the funds online to figure what funds would be smart to sell.  But the information provided is confusing (and seems to change) and it seems somewhat complicated. Any advice on how best to proceed such as what metrics to base the decision on?

B. Dempsey, San Antonio TX

A. The goal of tax loss harvesting is, through a careful series of sales, to offset some gains you might have from selling an asset with losses you might incur in the same calendar year. Losses that offset gains can leave you with a smaller tax bill. This is especially relevant if you have highly appreciated assets, or assets that were gifted to you that were bought at a much lower price. (Having a “low basis” in investment lingo.)

That’s the theory. 

Tax loss harvesting is easiest to understand on individual stocks.  Let’s say your Google stock appreciated by $50K based on where you sold it and you owed $7,500 on the gains because of the 15% long term capital gains tax rate. And then let’s say you also sold Pepsi in the same year, and you lost $10 thousand between where you bought it and where you sold it. The $10 thousand loss on Pepsi can be netted against the $50 thousand gain on Google if the sales occur in the same year. The result: you are only taxed 15 percent on $40 thousand in capital gains, and your tax bill drops by $1,500. Which is cool. 

But frankly it isn’t probably as important a factor for your long term net worth than the decision in the first place to own, or not own, Google or Pepsi. And in what proportions, and for how long.

The biggest choice is the investment itself, not the taxes

As always when people decide to get clever about saving on taxes, my very strong instinct is to remind them that taxes are the tail, stocks are the dog. Do not let your clever tax strategy (the tail) determine your investment asset allocation (the dog).

You can do this same netting of gains and losses on short-term stock holdings as well, which usually incur a higher tax rate since short term capital gains taxes match your income tax rate. Probably something above 15 percent.

If this seems confusing so far, I think that’s a good sign you don’t want to do it on your own and you may either need to hire an advisor or deputize your existing advisor to do it for you. 

I’m usually somewhere between skeptical and opposed to introducing investment complexity and additional advisors to one’s investment life, so I’ll try to offer a bit more about the narrow set of situations you might consider this for, as well as ways to accomplish this over time.

Tax loss harvesting is something you’d only do in your taxable (non-retirement) accounts, since it’s supposed to address the potential problem of capital gains. You won’t ever pay any capital gains in your tax-deferred retirement accounts.

I think it’s also worth saying up front that the most tax-efficient strategy you can do with your taxable investment portfolio in every case is: never, ever sell. 

Under current law, assets you never sell produce no capital gains taxes at the time of your death for you or your heirs. While your advisor is suggesting you “do something” (rebalancing) and then “do another something” (tax loss harvesting) as a result, my instinct is usually to tell people to “do nothing,” especially if you want to be tax-efficient. 

If you do go ahead and reposition your portfolio anyway, it becomes relevant at the end of the year in which you might pay capital gains to think about whether other sales you can do might produce tax-offsetting losses. 

In 2023, it would not have been surprising if you had losses in your bond portfolio, for example. Individual securities that went down from the time you bought them would be other candidates for locking in losses, although I again would not advise selling something just “for the taxes.” 

As for tax loss harvesting by selling a small-cap or medium-cap mutual fund, that seems too difficult for an individual to undertake on their own. You probably need to engage with an advisor if you want to do that, and that’s going to cost you money, which will raise the issue of whether a tax loss harvesting strategy is overall worth it. (more on that below) 

Another skeptical note, from me: Does incurring taxes by selling your existing low-cost mid-cap and small-cap index funds, and then doing tax-loss harvesting after the sales, truly improve your portfolio? In most market environments indexes of different capitalization are very highly correlated, so you are getting questionable improvements while upping your tax bill and maybe upping your management fees? 

There are at least two other ways to rebalance in a more tax efficient way. One would be to direct new purchases from the bond interest payments and stock dividends into larger cap funds. It would take a longer period of time but without any capital gains taxes. Another would be to just decide any new purchases go into large caps, but without selling the existing positions. A third way is to make the reallocation through changes to your non-taxable portfolio (like within a retirement account), as that doesn’t create a tax bill. Obviously I don’t know the positions of your portfolio and I don’t know your specific financial situation. I’m just a skeptical guy asking whether this advisor is really helping, or is this advisor making suggestions that just look like they are helping?

Going slightly beyond your question, there also exists the relatively new idea in investment management of actively tax-loss harvesting your existing taxable portfolio, not for rebalancing but specifically for tax efficiency.

Brokerages offer tax-loss harvesting strategy as a service within a portfolio that can act like a mutual fund. Fidelity for example offers something that should offer the performance of the S&P500 index, but at any given time they buy and sell individual stocks in ways that minimize capital gains taxes through tax loss harvesting. Since they charge 0.2 to 0.4 percent for this service, they would need to deliver some after-tax outperformance.

Fidelity and other brokerages offer tax-managed investing. For a fee, of course.

An academic research study from 2020 suggests that a tax loss harvesting program like this could save between 0.8 and 1.08 percent per year on your portfolio.

Since tax loss harvesting adds complexity to your investment life, I think it only becomes relevant if you have a large – probably multi-million dollar – taxable portfolio. 

At that scale, paying an advisor to generate an additional estimated 0.6 per year on your taxable portfolio may make sense.

A version of this ran in the San Antonio Express News and Houston Chronicle.

Post read (23) times.

End This Pain

The Federal Trade Commission recently sued the largest anesthesia-provider in Texas and its private equity owners. 

As the dominant provider in Houston and Dallas, ten-times larger by revenue than its nearest competitor in Texas, US Anesthesia Partners Inc is accused by the FTC of reducing competition and unfairly raising prices. 

According to the FTC complaint, private equity firm Welsh Carlson Anderson & Stowe noticed a fragmented market 11 years ago. They began a process of “rolling-up” anesthesia practices in Texas cities Houston, Dallas, Austin, San Antonio, Tyler, and Amarillo, until they’d built a behemoth involving 1,000 doctors, 750 nurses and over a dozen practices. 

US_Anesthesia_partners

As a result of its dominant position in its major markets, the FTC claims, the firm controls 60 percent of hospital-only anesthesia costs statewise, and 43 percent of cases. With that, the firm has been able to raise prices significantly, with reimbursement rates twice the median of other providers in Texas. The FTC quotes an email from a member of the anesthesia firm who wrote “Cha-ching” after completing another anesthesia practice acquisition, on the expectation that they would be able to extract monopolistic profits from their dominant position.

I have three reasons for mentioning this lawsuit against the anesthesiologist private-equity roll-up.

The first, most trivial point, is about the dangers of email in business.

You guys, this is in no way legal or financial advice but seriously, avoid writing “Cha-ching” in a celebratory email if you work for a private equity firm. Sure, you can think it, you might even say it to your buddy over post-acquisition drinks, but just please don’t write it down. That email could cost you and your partners a lot of money. 

The second, more profound point, is that this case gives us a sense of an important federal government and national business trend in 2023.

We are in year 3 of a significant shift to a much more activist antitrust phase of the federal government in its enforcement of market competition. Lina Khan, the FTC commissioner, embodies this shift. She established herself as a leading scholar rethinking antitrust rules with respect to technology giants such as Amazon, with a highly influential article entitled “Amazon’s Antitrust Paradox” written while she was still a law student at Yale University.

Lina_khan
Lina Khan, FTC Char

Most of the attention toward the FTC’s actions in recent years – with Khan as chairwoman – has focused on how the commission might target tech industry giants, such as Amazon, Alphabet (Google), Microsoft, and Apple for anti-competitive practices. 

This anesthesia roll-up case in Texas is an example outside of the technology industry of the FTC’s more activist stance. Traditionally the FTC focused on correcting situations where a monopolistic business might unfairly raise prices because of an absence of competition. But watch the tech space over the next year as the FTC is expected to bring more aggressive enforcement there on anti-trust theories beyond “monopolies lead to higher prices for consumers.” 

For its part, US Anesthesia rejects the FTC’s case and says it is based on “flawed legal theories and a lack of medical understanding about anesthesia.”

My third reason for bringing this up is personal. This is a follow-up to an earlier post I wrote in which I mentioned an anesthesia-billing problem that I found absolutely egregious.

I got an in-network preventive colonoscopy in June 2022 (to celebrate turning 50), covered by my insurance company Blue Cross Blue Shield of Texas. This procedure included anesthesia (because duh), but I learned 11 months later, in May 2023, that the anesthesiologist Alamo Sedation Associates was not considered in-network for my insurance at the time. I had first met the anesthesiologist who did the procedure approximately 90 seconds before going under, while gowned and sideways on a gurney. It had never occurred to me to look over my shoulder and ask at that special moment, “Hey, are you in-network with Blue Cross Blue Shield?” 

In May 2023, Alamo Sedation Associates sent me an invoice of $1,920 for their service. A month later this bill was reduced to $1,785.82 when BCBS paid $134.18 as an in-network payment. Over the course of the next 4 months I refused to pay the $1,785.82 balance.

Alamo_sedation_associates
A Very Bad Experience

Astute readers wrote to me in August that a federal law passed January 2022 made this kind of ‘surprise bill’ illegal. Blue Cross Blue Shield representatives, when presented with this situation by me over at least a half-dozen phone calls, claimed this law only applied to emergency-room bills. Most times I called them they claimed “oh, it should be resolved at some point, but we can’t promise it will be.” Four months later it wasn’t resolved.

Meanwhile, collection agency Quantified Management Services, hired by Alamo Sedation Associates, began to threaten my credit for non-payment of $1,785.82, via letters and phone texts in late August.

From the Alamo Sedation Associates PLLC website: “We accept any insurance that the facility where you are having the service accepts. Because we are an ancillary provider, we typically do not need to contract separately with your insurance to be processed in-network (several BCBS plans are the exception).” The first two sentences simply aren’t true, and the parenthetical phrase at the end is what drove me crazy, for months. Alamo Sedation Associates did not have a live person who would answer any of my phone calls, only an automated voicemail system and recorded messages about where to pay their invoice. Although I don’t think they are part of US Anesthesia Partners, the vibe the Alamo Sedation Associates PLLC website gives is that they are owned by a for-profit company based 3,000 miles away and unreachable on any day ending in the letter Y.

Blue Cross Blue Shield failed to resolve the bill after 6 months and countless phone calls. I imagine this same scenario being played out among tens of thousands of patients, most of whom would either pay the bill or have their credit wrecked. The experience was awful, predatory, and I think, illegal.  

Charles Riley of Riley and Riley, Attorneys at Law in San Antonio, who represents patients in disputes with health care providers and insurance companies, disagreed with BCBS.

Once I signed on with Riley, he wrote a letter letting them know he represented me and disputed the charge. The bill was zeroed out by BCBS, the anesthesia provider, and the collection agency. I found out about Riley’s success with my situation last week.

Charles_Riley_attorney_san_antonio
Charles Riley and firm

In terms of consumer and patient harm, ignoring the federal surprise billing law, threatening my credit, and refusing to honor the in-network claim, I believe and my attorney believe that both Alamo Sedation Associates and Blue Cross Blue Shield were in dangerous potential class-action lawsuit territory for them. By zeroing out my bill, they avoided us finding out for sure. But if you are stuck in a similar situation, I’d recommend you find an attorney like the one who represented me. 

There’s nothing wrong with the practice of anesthesiology. This is essential medicine! But the part of the business that involves surprise billing, jacking up prices in Texas, being jerked around by your insurance company for six months, and ignoring consumer protection laws isn’t great. 

Post read (12) times.