The Art of Balancing Risk
Just a few short years ago alternative investments such as hedge funds weren't the dirty words they are today. They "were rock stars" between 2004 and 2007, says Ivy Bibler, senior vice president and senior healthcare advisor at Bank of America in Orlando, FL.
But those rock stars turned into county-fair performers in 2008, helping trigger some of the most significant hospital investment losses ever. "Those asset classes have been the most volatile and down the most," says Bibler. Risk took on a whole new meaning in 2008. Hospital investment losses soared as high as 35% over the previous year. Alternative investments were just part of the problem. Over the past several years, as hospitals experienced strong operating margins, they began taking on increasing amounts of investment risk, which also included a higher percentage of equities.
"Over the last five years you have been seeing hospitals get more into equity investments, both international and domestic, and alternative types of investments like private equity funds or hedge funds," says Catherine Jacobson, CPA, senior vice president, CFO, and treasurer at Rush University Medical Center in Chicago. This type of investment strategy did not exist a decade ago, except at a handful of hospitals, she adds.
New day, new strategy
Rush University Medical Center shares a similar story with most hospitals. Its investment portfolio has experienced heavy losses in the past year. Year-to-date through March 31, 2009, investment losses totaled $107.9 million. As of July 2009, the academic medical center experienced 7% in investment income losses year over year.
"Regardless if you had a fixed income, domestic equity, or an international portfolio . . . you were going to get hit no matter what. There was no place to hide," says Jacobson, who is also the national chair for the Healthcare Financial Management Association.
As investment losses have mounted and cash availability decreased, hospitals face significant changes to their operations and investment portfolios. "The first reaction, and we did it here as well, is hospitals went to their capital budgets and started to scale back. They went into cash preservation mode," says Jacobson. At the same time, CFOs, driven both internally and by the board, are taking a hard look at investments to make sure they "absolutely understand the risk and return dynamics of their investment portfolio," says Jacobson, noting that some of the "less sophisticated hospitals" that dipped their toes into equities and alternative investments without performing a risk analysis on the front end, have pulled out of these riskier investments.
Larger systems, however, are mostly staying the course, says Jacobson. "I have heard very few people say they will significantly change their asset allocation because they simply have stepped back, looked at it, assessed their risk, and said, 'Maybe we need some minor tweaking, but we think we are pretty OK,'" says Jacobson.
Market volatility has caused Jacobson and her team to make some changes even though she says the organization has been somewhat conservative in its investments all along. While Rush University Medical Center's fixed income portfolio had intermediate bonds and fixed income, Jacobson says there was still some exposure to international equities and global bonds that were moving around more than the academic medical center could tolerate and were thus liquidated. "We also had some inflation-protected assets that were moving around a little bit. I think long term those investments would have been perfectly fine, but we reached a point that we couldn't tolerate the losses and the volatility anymore and moved them into straight money market funds."
Rush University Medical Center's investment portfolio as of June 2009 was roughly 27% cash, 41% fixed income, 19% domestic equities, 3% international equities, 2% hedge funds and 6% private equities. This excludes its off-balance-sheet pension trust. In September 2008, the medical center had half as much allocated to cash at 13% and close to 24% more in fixed income at nearly 54% allocation. Jacobson says investments have yielded a 3.5% return through May.