Hospitals May be Leaving Potential Investment Returns on the Table
That May be Needed to Support Future Organizational Priorities
BOSTON (November 14, 2018) – Many hospitals and hospital systems have accumulated billions of dollars in their investment “war chests” – buttressed in part by an unusually long period of strong market performance, robust patient volumes, and other factors. But significant revenue and expense challenges loom for these institutions, and their investment pools may be critical to subsidize operations and fund capital expenditures in the coming years.
According to “Mission Critical: Maximizing the Impact of Hospital Investments,” a new report from investment firm Cambridge Associates, many hospitals have not focused on investing their pools in an optimal way – and may be jeopardizing their future. It suggests that hospitals may be able to avert the problem by re-evaluating their investment strategies across the multiple asset pools that hospital organizations typically oversee and, if appropriate, taking strategic steps such as restructuring investment portfolios or applying excess portfolio liquidity to investments that can achieve above-market long-term returns.
“For many hospitals, their pools of capital are going to become a source of cash, not a destination for it,” says Tracy Filosa, Managing Director and Head of the CA Institute, which stewards the firm’s comparative client data and research. “As forces within the healthcare industry combine with changing financial market conditions, the challenge hospitals face managing capital becomes all the more urgent.”
The shifts that stand to make hospitals more reliant on their capital reserves include margin compression because of changing patient demographics, lowering reimbursement rates; and a decrease in hospitalizations due to pressure from insurers, and incentives that shift visits to lower cost outpatient centers. These pressures come as investment challenges and market volatility also are rising, and all investors are facing the reality of a nine-year bull market that will inevitably end.
The report notes that while the “Endowment Model” of investing – equity bias, diversification and use of less-liquid alternative investments – has been a “gold standard” for many universities and other institutions, hospitals need their own approach or variations because of the different demands on their coffers.
“Hospitals are not endowments,” says Hamilton Lee, Managing Director and an Outsourced Chief Investment Officer (OCIO) at Cambridge Associates. “They have a different operating model from other investors, tend to rely more heavily on debt, be sensitive to debt ratings, have multiple pools with different objectives and have less predictable flows into and out of those pools. And, to boot, hospitals differ from each other much more than university and foundation endowments do, so there’s no formula.”
The solution, according to the report, starts with an extensive enterprise review and analysis that may show where more risk and illiquidity are not only acceptable, but even vital to the hospital’s future. Though illiquid private and alternative investments often bring longer “lock-ups”, they also hold an opportunity to generate better returns than other investments.
“Many hospitals are indeed missing out on returns that could be supporting their mission and contributing to needed resources. In that vein, it’s important for more hospitals to recognize there’s a risk in not taking on an appropriate amount of investment risk,” says Jeff Blazek, Managing Director and an Outsourced Chief Investment Officer (OCIO) at Cambridge Associates.
“All of the variables that hospitals contend with conspire to lead them to be more conservative – i.e., having higher bias to liquidity – than necessary. By being thoughtful about the unique characteristics of each pool of capital hospitals can make investments that maximize returns, strengthen balance sheets, and ultimately build out their long-term capital,” says Blazek.
To better position asset pools to support the institution, the report outlines a process that hospitals can take to effectively re-evaluate and realign their investment strategies. This may include:
- Performing a detailed analysis of the links between the hospital’s debt and investment assets so it’s clear how the investment pools and strategy need to be aligned to maintain appropriate covenants and ratios.
- Determining if the hospital’s various pools of capital can be grouped together in terms of investment objectives and realigned to incorporate strategies more appropriate to each ‘group’s’ purpose. This can help optimize portfolio efficiency.
- Conducting a robust stress test, by simulating the impact of a severe market or adverse economic event to confirm the enterprise’s resilience in the face of worst-case scenarios.
“Hospitals will likely see continued operational and investment market headwinds, requiring greater dependence on their investment pools. At the same time, many hospitals are more cautious than they need to be,” says Lee. “While they may have merely missed opportunities to enhance returns in recent years, continuing their current approach in the coming years may come at the detriment of their long-term missions.”
About Cambridge Associates
Cambridge Associates is a leading global investment firm. We aim to help endowments & foundations, pension plans, and private clients implement and manage custom investment portfolios that generate outperformance so they can maximize their impact on the world. Working alongside its early clients, among them leading university endowments, the firm pioneered the strategy of high-equity orientation and broad diversification, which since the 1980s has been a primary driver of performance for institutional investors. Cambridge Associates delivers a range of services, including outsourced CIO, non-discretionary portfolio management, and investment advisory services.
Cambridge Associates maintains offices in Boston; Arlington, VA; Beijing; Dallas; London; Menlo Park, CA; New York; San Francisco; Singapore; and Sydney. Cambridge Associates consists of five global investment affiliates that are all under common ownership and control. For more information, please visit www.cambridgeassociates.com.