ObamaCare Portfolio Picks

Health care inflation is coming. Profit from these money-saving firms.

According to PricewaterhouseCoopers health care prices are likely to rise 8% in 2011 and 8.5% next year. So much for ObamaCare bending the cost curve. Cost cutting will likely be left to employers, as they attempt to offer insurance to workers without going broke.

Venture capitalist Stephen Krupa sees opportunity in this mess. His New York City firm, Psilos, manages $580 million in funds that invest exclusively in health care IT, device and services companies. "Our sole focus is to fight health inflation," says the former Wasserstein Perella banker. "If you look at the CBO projections and take them seriously, which is hard to do, there is a tail-off in inflation underlying the models. How can you make that assumption? There have to be technological breakthroughs."

Krupa's portfolio of private companies chips away at costs, each in a different way--by offering a medical device at a lower price, a technology that makes buying insurance or measuring risk more efficient, or a service that pushes delivery away from acute care and toward prevention. His biggest hit has been ActiveHealth Management, a company that uses analytical software to help insurers get ahead of expensive diseases. Aetna ( AET - news- people ) bought it for $400 million in 2005, returning seven times Krupa's investment. Last year UnitedHealth ( UNH -news - people ) bought another Psilos company, called QualityMetric, a patient-surveying firm that measures drug efficacy. Krupa says he earned a 500% return on the deal.

Right now Krupa is pushing the cost-cutting angle with several other new investments. SeeChange, a small insurer in California, discounts premiums based on how much preventive care a patient gets. Gamma Medica has developed a new kind of camera that scans dense breast tissue for tumors; the scan costs a third of an MRI. It's already in use at hospitals like Mayo Clinic. ExtendHealth brokers health care and pension plans for retirees. It's gearing up for the new health exchanges that open in 2014.

It's more difficult to find serious inflation-fighting companies among publicly traded stocks. Big device companies likeMedtronic ( MDT - news - people ), Johnson & Johnson (JNJ - news - people ) and Boston Scientific ( BSX - news -people ) sell expensive products that fuel the cost surge. Meanwhile, many HMOs have abdicated the role of managing spending and are turning into commoditized claims-paying utilities.

Krupa sees a few exceptions. On the insurance side Aetna and UnitedHealth seem the most committed to becoming clinically oriented--that means using data-mining technology to identify expensive patients and then deploying preventive clinical programs to keep them out of the hospital. Krupa also believes that the insurance companies that gain market share will be the ones that embrace "value-based design"--in which you pay for health outcomes and not just for procedures and office visits. Both United and Aetna are piloting such projects.

As for the IT side? "This is not an industry where the technology departments have been innovators," says Krupa. An exception is Allscripts, the Chicago software company that specializes in digitizing records at doctors' offices. Allscripts sells the database of records and the interface for the doctor and has an open-source approach to applications running on its platform.

Among device companies, Krupa recommends the women's health company Hologic ( HOLX - news - people ). Like Gamma, Hologic is pioneering an imaging technology called tomosynthesis for patients who need more than a mammogram but don't want to pay $1,000 for an MRI. Another Krupa pick is NxStage, a home-dialysis technology firm that's disrupting dialysis centers like DaVita ( DVA - news - people ) and Fresenius.

RIDING THE HEALTH COST CURVE
DESPITE OBAMACARE'S CLAIMS, HEALTH CARE INFLATION IS A SURE THING. HERE ARE STOCKS THAT SHOULD BENEFIT.

COMPANY	RECENT PRICE	2011 EST P/E	MARKET VALUE ($MIL)
AETNA	$43.79	10	$16,618
ALLSCRIPTS HEALTHCARE SOLUTIONS	20.02	22	3,808
HOLOGIC	20.64	17	5,395
NXSTAGE MEDICAL	18.01	NA	978
UNITEDHEALTH GROUP	49.39	12	53,511

PRICES AS OF JUNE 2. NA: NOT AVAILABLE. SOURCE: INTERACTIVE DATA AND THOMSON REUTERS IBES VIA FACTSET RESEARCH SYSTEMS.

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5 Tax Tips for Fund Investors

Stocks and bonds rewarded investors with relatively robust performance in 2010, which means it's more likely that your mutual funds ended the year with gains instead of losses. That's great news for the net value of your portfolio, but combined with the market's strong start this year, the prospect of having to pay more in capital gains taxes in the future is not as appealing.

By law, fund managers must pass on almost all gains their fund accumulated during the year to investors in the form of capital gains distributions. Investors must pay taxes on those gains regardless of whether they choose to reinvest in more shares of the fund. Depending on how long you hold an investment, capital gains are taxed differently; long-term capital gains rates apply to investments held for longer than one year, while short-term capital gains taxes affect investments held for less than a year.

Despite last year's gains, Morningstar analyst Christopher Davis says the tax burden on mutual fund investors should be fairly light, mostly because fund managers still have substantial losses on their books from 2008 that can be used to offset capital gains achieved in 2010. (Mutual funds can carry forward losses for up to seven years.) According to the Investment Company Institute, mutual funds passed on just $3.4 billion in capital gains taxes during the first nine months of 2010, comparatively less than the $6.2 billion during the same period in 2009, and significantly less than the $132 billion investors were stuck with for the whole of 2008.

[See The Tale of Two Taxes.]

While investors might not feel the bite of a bigger tax bill this year, Davis says the effects of a stronger, sustained economic recovery might mean the days of diminutive capital gains distributions are numbered. "Some funds have made so much money since the bottom, so a lot of those tax losses that they were able to use don't exist anymore—they've been mostly wiped out," he says. "Presuming things continue on pace, I think that you could expect to see a more normal environment for taxes."
Furthermore, there are no guarantees that today's capital gains tax rates—recently renewed by President Obama—will remain at current levels after their scheduled expiration in 2012. "The only saving grace we have right now is the lower capital gains rates. Chances are, that's going to go away sooner or later," says Cindy Hockenberry, tax knowledge center supervisor at the National Association of Tax Professionals. "Will they change capital gains rates to be something more, or still have a soft spot for investors? After 2012, it's a crapshoot."

Experts say tax considerations should never direct your investment decisions, but there are some strategies you can use to minimize Uncle Sam's impact on your portfolio. U.S. News asked experts for some tax-friendly techniques that could save you money on your tax bill next year:

Location is key. As with real estate, making sure your investments are in the best place is the first big step toward avoiding unnecessary taxes. For example, consider housing more aggressive mutual funds in a Roth IRA. Because your contributions to a Roth IRA are taxed upfront (as opposed to traditional IRAs or 401(k)s, which are taxed as income upon withdrawal) you'll never pay income tax on the growth of your investments, whether it comes from dividends or capital gains. "It's an ideal spot for fast-trading funds that might generate a lot of gain," Davis says. If you put a fund that derives most of its gains from capital appreciation in a 401(k), you'll ultimately end up converting those capital gains (which are taxed at a lower rate) into income (which is taxed at a higher rate) when you withdraw from your 401(k), Davis says. "In a Roth, investors don't pay taxes on capital gains, so it makes more sense to put high-returning investments there," he adds.

[For more investing and money advice, visit U.S. News Money, or find us on Facebook.]
Look for low turnover. When a manager sells a security from a fund, there is the potential for investors to incur capital gains. Managers of funds with longer-term outlooks tend to buy and sell securities much less frequently, which translates into lower turnover and fewer taxable capital gains. You can check turnover rates on most fund companies' websites or by visiting Morningstar. Generally, a turnover rate of 10 percent or below is considered tax-efficient. Also, most index funds, which track specific market indices, are generally a good bet for tax-conscious investors, Davis says.

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