A weight­ing game

Height­ened stock mar­ket risk mo­ti­vates some health sys­tems to re­think their in­vest­ment al­lo­ca­tions

Modern Healthcare - - Technology - By Tara Ban­now

It's rel­a­tively rare in the rough and tum­ble world of stocks and bonds for an in­vest­ment team to stick with the same recipe for years and years.

At the UPMC health sys­tem, how­ever, at least one tried and true method hasn’t changed since the late 1990s: its as­set al­lo­ca­tion strat­egy. Rest as­sured its in­vest­ment recipe, which ded­i­cates 65% to eq­ui­ties, won’t change based on a bad stock mar­ket day, week or even year, said Tal Hep­pen­stall, UPMC’s ex­ec­u­tive vice pres­i­dent and trea­surer.

In­deed, it even held steady through the deep re­ces­sion that started in 2008.

“We never once got a phone call from any of our in­vest­ment com­mit­tee mem­bers or any of our se­nior staff about, ‘Oh my good­ness, we have to do some­thing dif­fer­ent,’ ” he said.

Such an un­wa­ver­ing equity pol­icy works well for UPMC, which gained more than $300 mil­lion on in­vest­ments last year, but other not-for-profit health sys­tems are tak­ing a more ac­tive ap­proach.

As the stock mar­ket be­comes in­creas­ingly volatile and some economists pre­dict the U.S. is once again due for a re­ces­sion, some ex­perts say it’s pru­dent to step back and re-ex­am­ine as­set al­lo­ca­tion strate­gies and, even if a sys­tem’s long-term strat­egy stays the same, make small changes to their in­vest­ments based on how mar­kets are per­form­ing.

The down­side risk isn’t re­stricted to the stock mar­ket. The 10-year bond yield hit 3% last week, mark­ing the first time in­ter­est rates have been that high since 2014. Lisa Sch­nei­der, manag­ing di­rec­tor of not-for-prof­its and health­care sys­tems with Rus­sell In­vest­ments, said for roughly the past year, her firm has helped clients mon­i­tor not only their port­fo­lios’ equity risk, but the in­ter­est-rate risk com­ing from fixed-in­come as­sets as well.

“As in­ter­est rates rise, the per­for­mance of the fixed-in­come port­fo­lios falls,” she said. “Di­ver­si­fy­ing or any strate­gies they can in­clude to min­i­mize some of that risk will ben­e­fit them in the long run.”

Ris­ing rates have trans­lated to a neg­a­tive re­turn on the in­vest­ment-grade U.S. bond mar­ket, with the Bloomberg Bar­clays US Ag­gre­gate Bond In­dex down for the year about 2% as of April 26, af­ter post­ing a pos­i­tive re­turn the pre­vi­ous three calendar years.

Mean­while, stocks in the S&P 500 in­dex were down a col­lec­tive 7% from their peak value on Jan. 26, af­ter post­ing a gain in 2017 of 19%. The S&P 500 was down 1% for the year as of April 26.

Pos­si­ble re­sponses

Rus­sell In­vest­ments helps its clients make “tac­ti­cal shifts” in in­vest­ments in re­sponse to fac­tors like se­cu­rity val­u­a­tions, in­vestor sen­ti­ment or the busi­ness cy­cle, Sch­nei­der said. They can hap­pen within a sin­gle day. The changes are rel­a­tively small—maybe 5% to 10% in ei­ther di­rec­tion—and al­low health sys­tems to re­spond to changes quickly. Tac­ti­cal shifts don’t change health sys­tems’ more im­por­tant long-term in­vest­ment strate­gies, how­ever, she said.

“The most im­por­tant de­ci­sion they make is get­ting that long-term strate­gic al­lo­ca­tion right,” Sch­nei­der said. “That’s go­ing to drive the ma­jor­ity of the re­turn on their port­fo­lio.”

Hep­pen­stall said that while UPMC has done mi­nor mod­i­fi­ca­tions over the years, it does not do “tac­ti­cal shifts.”

UPMC’s ex­pe­ri­ence is much dif­fer­ent from that of Hartford (Conn.) Health­Care, which re­vamped its in­vest­ment port­fo­lio af­ter the Great Re­ces­sion, dur­ing which the sys­tem’s largest pen­sion fund—heav­ily in­vested in fi­nan­cial in­dus­try stocks— shed its value at twice the rate of the mar­ket as a whole, said Richard Stys, Hartford’s trea­surer and se­nior vice pres­i­dent of fi­nance.

These days, the sys­tem’s chief in­vest­ment of­fi­cer leads a team that prefers hit­ting sin­gles and dou­bles to four-bag­gers. “He doesn’t want the home run, but he wants some­body on first, he wants some­body on sec­ond, and he wants some­body on third,” Stys said.

“So it’s a very de­lib­er­ate shift in our port­fo­lio that re­ally has re­duced the volatil­ity,” he said. “We do not have knee­jerk re­ac­tions to the mar­ket’s move­ments.”

Ef­fects on debt rat­ings

From the per­spec­tive of rat­ings agen­cies, the mar­ket can play a role in hurt­ing a sys­tem’s debt rating if stock mar­ket gains play too big of a role in its fi­nan­cial struc­ture.

S&P Global isn’t likely to change a health sys­tem’s rating based on a weak mar­ket year, said Martin Ar­rick, a manag­ing di­rec­tor in S&P’s not-for-profit health­care group. That said, not-for-profit health sys­tems could be ex­posed to rating volatil­ity in the event of a mar­ket down­turn if they’re too de­pen­dent on non-op­er­at­ing rev­enue, he said.

Ar­rick said he’s ob­served a grow­ing re­liance on stock mar­ket in­vest­ments to mask un­der­ly­ing drops in op­er­at­ing per­for­mance. “Right now the strong mar­ket is help­ing a lot of folks,” he said. “If that weak­ens, then all of a sud­den the fact that their op­er­a­tions are con­sid­er­ably weaker, that could be a real con­cern.”

Kevin Hol­lo­ran, a se­nior di­rec­tor with Fitch Rat­ings, said for sys­tems with roughly half of their in­vest­ments in fixed-in­come as­sets and half in eq­ui­ties, a 2% drop in GDP would re­sult in a roughly 10% drop in their bal­ance sheets.

“It’s noth­ing dis­as­trous, but some­thing to keep an eye on,” he said.

S&P, Fitch and Moody’s In­vestors Ser­vice all take health sys­tems’ as­set al­lo­ca­tion strate­gies into con­sid­er­a­tion when de­ter­min­ing rat­ings. Fitch puts each is­suer un­der a stress test, hy­po­thet­i­cally sub­ject­ing it to a mod­est re­ces­sion, Hol­lo­ran said. Most suf­fer a bal­ance sheet drop of roughly 10% in the first year, he said. He couldn’t think of any that dropped more than 13%.

Sys­tems “are al­lowed to amass pretty good size bal­ance sheets,” he said. “That’s some­thing we want to make sure is sta­ble through the cy­cles.”

Moody’s tends to look fa­vor­ably upon not­for-profit health sys­tems that have good liq­uid­ity in their in­vest­ments and could quickly pull

money out if nec­es­sary, said Dan Stein­gart, a Moody’s vice pres­i­dent. The agency also likes to see di­ver­si­fied port­fo­lios that aren’t too heav­ily in­vested in eq­ui­ties. Stein­berg said he en­coun­tered a hospi­tal with 80% in eq­ui­ties, which he de­scribed as risky. The av­er­age is about 30%, ac­cord­ing to Moody’s.

Cloudy out­look

Rus­sell In­vest­ments doesn’t be­lieve U.S. eq­ui­ties will con­tinue to per­form bet­ter than their non-U.S. coun­ter­parts, as they have for the past decade, Sch­nei­der said. The firm is ad­vis­ing clients to di­ver­sify their port­fo­lios with re­spect to global eq­ui­ties to about 50% U.S. eq­ui­ties and 50% non-U.S. eq­ui­ties, she said.

That’s a trend Hartford Health­Care is ac­tively pre­par­ing for. Its chief in­vest­ment of­fi­cer in re­cent years has “logged a lot of miles,” to at­tend pri­vate equity lead­ers’ an­nual meet­ings at their head­quar­ters, mainly in Asia and Europe, Stys said. “It’s been a very de­lib­er­ate shift over the past four to five years, and it has re­ally panned out well for us,” he said.

Larger and more prof­itable health sys­tems typ­i­cally take big­ger risks, since they have the fi­nan­cial strength to weather stock mar­ket dips, whereas smaller sys­tems tend to be more con­ser­va­tive in their in­vest­ment prac­tices.

Toledo, Ohio-based ProMed­ica has 60% to 70% of its as­sets in­vested in eq­ui­ties, said Michael Brown­ing, the sys­tem’s chief fi­nan­cial of­fi­cer. The prac­tice has served ProMed­ica well in re­cent years; it raked in about $211 mil­lion in in­vest­ment in­come in 2017, more than dou­ble that of 2016.

“We are a lit­tle bit more ag­gres­sive with our in­vest­ment port­fo­lio,” he said. “It’s been very ben­e­fi­cial to ProMed­ica over the years, as you saw with last year.”

But even in a good year, Brown­ing cau­tioned that his team never gets too ex­cited. Like other sys­tems, ProMed­ica works off of long-term in­vest­ment strate­gies with the flex­i­bil­ity to re­act to acute changes baked in. Its in­vest­ment com­mit­tee meets quar­terly to see whether any­thing needs to be tweaked.

De­spite that flex­i­bil­ity, Brown­ing said the sys­tem is not in­clined to change its in­vest­ment port­fo­lio based on what could be tem­po­rary stock mar­ket volatil­ity. In fact, he said, it would take a sig­nif­i­cant mar­ket down­turn for the sys­tem to ask its in­vest­ment com­mit­tee for ap­proval to lower its equity in­vest­ments.

“We’re in it for the long haul,” Brown­ing said. “We don’t live quar­ter to quar­ter.”

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