Test­ing the wa­ters

Fac­ing calmer mar­kets, some not-for-profit hos­pi­tals are try­ing bolder in­vest­ment strate­gies

Modern Healthcare - - Cover Story -

See­ing a re­turn to nor­malcy in the econ­omy and mar­kets, in­sti­tu­tional health­care in­vestors are back in the game with some ag­gres­sively pur­su­ing al­ter­na­tive in­vest­ments. Not-for-profit hos­pi­tals and health sys­tems ex­pe­ri­enced the same scary plunge as other in­vestors when credit mar­kets seized and the re­ces­sion wors­ened in late 2008 and early 2009, lead­ing many to pull back from stocks and less-liq­uid in­vest­ments known as al­ter­na­tives to limit losses.

The de­ci­sion to con­sider an in­crease in in­vest­ments in stocks, hedge funds and other more risky in­vest­ments is a sharp U-turn from re­cent times when volatile mar­kets and a lack of liq­uid­ity led to a move into cash and fixed in­come. Not-for-profit health­care in­vestors’ ex­po­sure to U.S. eq­ui­ties had fallen, fu­eled in part by the drop in prices, to 24% of their port- fo­lios in fis­cal 2008, down from 31% the pre­vi­ous fis­cal year, ac­cord­ing to Com­mon­fund, which man­ages in­vest­ments for not-for-prof­its.

The move out of cash and fixed in­come may be the right one, though a big re­bound in eq­ui­ties has al­ready occurred. The stock mar­ket, as mea­sured by the Dow Jones in­dus­trial av­er­age, was up more than 60% as of last week from its 12-year low close of 6,547 on March 9, 2009.

In­vest­ment ad­vis­ers cau­tion that hos­pi­tals risked un­nec­es­sary losses by aban­don­ing long-term in­vest­ment poli­cies un­less changes to strate­gic plans or debt al­ter de­mands for cash. “Any time there’s a sig­nif­i­cant down­draft, emo­tion takes over,” said William Cour­son, pres­i­dent of Lan­caster Pol­lard’s In­vest­ment Ad­vi­sory Group. Those who aban­don po­lices in fear miss gains as mar­kets re­verse course, he said. “It’s un­for­tu­nate.”

Lisa Martin, a se­nior vice pres­i­dent with Moody’s In­vestors Ser­vice, said larger health sys­tems ap­pear to be slowly looking at mov­ing port­fo­lios back into eq­ui­ties and al­ter­na­tives from cash safe havens, but with more at­ten­tion to the cash re­stric­tions and lim­its of in­vest­ment ve­hi­cles.

Among those po­ten­tially mov­ing back into stocks and al­ter­na­tives are As­cen­sion Health

and Ad­vo­cate Health Care. St. Louis-based As­cen­sion will cut back its cash and fixed­in­come as­sets, which grew un­der the Ro­man Catholic sys­tem’s strat­egy to pro­tect liq­uid­ity last year, in fa­vor of al­ter­na­tive and eq­uity in­vest­ments, a re­cent Moody’s re­port said.

At the end of De­cem­ber, As­cen­sion held $5.6 bil­lion in a long-term fund spread across var­i­ous in­vest­ments, the sys­tem’s fi­nan­cial records show. (As­cen­sion also has an­other $661 mil­lion in a short-term fund.)

Cash and fixed in­come equaled roughly 44% of the long-term fund, with al­ter­na­tives and eq­ui­ties at 21% and 35%, re­spec­tively.

The sys­tem’s in­vest­ment pol­icy calls for cash (and fixed in­come) and al­ter­na­tives to each ac­count for 30% of the fund with the rest in eq­ui­ties.

Move to al­ter­na­tives

To reach its tar­gets, As­cen­sion will need to bol­ster its in­vest­ments in hedge funds, pri­vate eq­uity and other al­ter­na­tives, a strat­egy the sys­tem launched dur­ing the boom years be­fore the credit cri­sis. As­cen­sion said in 2006 it would in­crease al­ter­na­tive as­sets to 30% of its port­fo­lio from 3%.

In ad­di­tion, the sys­tem, which op­er­ates more than 70 hos­pi­tals in 15 states and the District of Columbia, has re­cruited in­vest­ment ex­perts in re­cent months to help man­age its con­sid­er­able as­sets.

In Fe­bru­ary, As­cen­sion hired Josh Ka­plan, the chief in­vest­ment of­fi­cer of Drexel Uni­ver­sity, to be­come the sys­tem’s se­nior di­rec­tor of hedged strate­gies. Last Septem­ber, it re­cruited David Erick­son from the Uni­ver­sity of Wis­con­sin, where he man­aged the foun­da­tion’s $2.2 bil­lion in as­sets, to be­come As­cen­sion’s first chief in­vest­ment of­fi­cer.

As­cen­sion of­fi­cials de­clined to com­ment, said sys­tem spokes­woman Trudy Hamil­ton.

In Oak Brook, Ill., Ad­vo­cate Health Care has launched a re­view of how its in­vest­ments are di­vided across as­sets. Ex­ec­u­tives last rou­tinely re­viewed the sys­tem’s pol­icy in 2008 and had con­sid­ered boost­ing its ex­po­sure to al­ter­na­tives and eq­ui­ties, said Do­minic Nakis, se­nior vice pres­i­dent and fi­nance chief for eight-hospi­tal Ad­vo­cate. But that was be­fore the past 18 months.

In­stead, Ad­vo­cate be­gan in the sum­mer of 2008 to hold onto cash, he said. As eq­uity val­ues fell, and as Ad­vo­cate poured op­er­at­ing in­come into cash and fixed in­come, the highly liq­uid as­sets grew as a share of its port­fo­lio. As­sets in cash and short-term money mar­kets rose from 7.5% to roughly 18%, he said.

Since last July, in­spired by im­proved credit and eq­uity mar­kets, Ad­vo­cate has grad­u­ally poured more of its as­sets back into eq­ui­ties in an ef­fort to reach long-stand­ing tar­gets: half cash and fixed in­come, 38% eq­ui­ties, and the rest al­ter­na­tives. Cash and fixed in­come ac­counted for 64% of the port­fo­lio last year but have since dipped to about 57%, he said. Nakis said he is not cer­tain whether Ad­vo­cate will change its pol­icy once its re­view is com­plete this year.

Re­treat too far from risk and in­vestors lose out on re­turns, said Verne Sed­lacek, pres­i­dent and CEO of Com­mon­fund. He ac­knowl­edged that few cal­cu­lated the risk of events that erupted in 2008 prior to the credit cri­sis, and in­vestors should scru­ti­nize poli­cies for fur­ther risk. But he said poli­cies should seek a bal­ance be­tween ac­cept­able risk and re­turns.

Some see ad­van­tages in al­ter­na­tive as­sets de­spite an­a­lysts’ height­ened wari­ness of in­vest­ments. “We’ve kept our pol­icy in­tact,” said Dave Cyt­lak, chief fi­nan­cial of­fi­cer for 181-bed Blan­chard Val­ley Health Sys­tem, in Find­lay, Ohio, and con­tin­ues to stick to its strat­egy, which puts 65% of its in­vest­ments in eq­ui­ties and an­other 15% in hedge funds or real es­tate.

Cyt­lak said strong cash re­serves al­low the hospi­tal to take risks with its $139 mil­lion port­fo­lio that oth­ers may find un­com­fort­able.

Moody’s noted the in­vest­ment strat­egy war­ily, but said risks were off­set by di­verse in­vest­ments and strong op­er­at­ing mar­gins.

Cyt­lak de­scribed Blan­chard’s gov­ern­ing board as highly knowl­edge­able and comfortable with the two-cam­pus hospi­tal’s longterm in­vest­ment pol­icy, which was tested against var­i­ous sce­nar­ios by an ad­viser. And Blan­chard fin­ished a ma­jor ren­o­va­tion in 2007 and has no im­me­di­ate plans for cap­i­tal spending, he noted.

Boost­ing cash

Blan­chard did boost its al­lo­ca­tion to cash by $35 mil­lion in early 2008, when the hospi­tal was forced to bid on its own debt af­ter the brew­ing credit cri­sis top­pled an auc­tion mar­ket for tax-ex­empt bonds, Cyt­lak said.

The hospi­tal saw an op­por­tu­nity and con­tin­ued to use the cash to in­vest in auc­tion bonds or other short-term, tax-ex­empt debt af­ter re­fi­nanc­ing its own debt, but the sys­tem will soon re­turn the cash to long-term in­vest­ments, Cyt­lak said.

Some hos­pi­tals were un­able to ad­just port­fo­lios to meet in­vest­ment tar­gets as mar­kets fell be­cause losses would run afoul of lend­ing agree­ments, said Ni­cholas Bauer, a se­nior con­sul­tant for not-for-profit hos­pi­tals and health sys­tems at MBO Cleary Ad­vi­sors. Agree­ments with banks and other lenders to hos­pi­tals and health sys­tems stip­u­late a min­i­mum cash re­serve. Vi­o­lat­ing those

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