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The Risky Get Riskier

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Hedge funds and private equity funds are all the recent rage on Wall Street. It's not that plain vanilla stocks have lagged, but when compared to so-called "alternative investments," their recent returns seem pedestrian. That's why many hospitals with available cash may feel an irresistible urge to jump in with both feet.If they do, smaller hospitals and health systems will find themselves in the company of large institutional investors like pension funds, universities, and large hospitals and health systems that can wait a long time for such investments to pay off. Over the past dozen years or so, many of these players have seen outstanding returns with alternative investments, but rating agencies are warning healthcare organizations that such investment vehicles can bring not only significant returns, but an increased risk of a big bust. Rating agencies are amending their rating methodology to reflect this fact. "There's unique risk associated with these investments," says Ken Rodgers, a director in the public finance group at Standard & Poor's in New York. "The first thing we want to see is that hospitals have written investment policies, and that if they are investing in alternative ones, they specify the criteria by which they're making the decision on which investments are eligible."Rodgers says alternative investments can be an important part of a diversified portfolio for big hospitals, and especially hospital systems. What can be troubling is that many may not commensurately amend their governance policies regarding such restrictive investments.For example, hospitals' ability to liquidate alternative investments for capital purposes is limited over time-the crux of the issue in two recent reports by both Moody's Investors Service and S&P. Hedge and private equity funds often have long lock-up periods, leading to concern that a heavy concentration in such investments might leave too little easily accessible capital available if needed for debt service and operations.Duke University Health System has been involved in such structures for at least a decade, says Ken Morris, the system's senior vice president, treasurer and chief financial officer. Duke has about $6 billion under management through its DUMAC investment subsidiary; of that, about 43.5 percent is in alternative investments, Morris says. That part of the portfolio has done well, he adds, averaging a 16.3 percent annual return over the past 10 years. But Morris is under no illusions about the strategy's potential risks. "Hedge funds can blow up from time to time," he says. "The way you counter that is through diversification." -Philip Betbeze