Nonprofit Hospitals Shifting Investment Portfolios

Nonprofit healthcare organizations are gradually shifting traditional investment strategies away from bonds and other fixed income securities toward more highly diverse portfolios that could make them less vulnerable to market swings, multiyear analyses from Commonfund show.

William F. Jarvis, managing director and health of research with the Wilton, CT-based financial advisors, says nonprofit healthcare organizations are taking cues from colleges and universities that have seen generally strong investment returns over the last 20 years using a more diversified "endowment model."

"Healthcare organizations have historically had portfolios that were much more heavily allocated to bonds and fixed income securities than other types of nonprofits, certainly much more allocated to bonds than the typical college or university would have," Jarvis told HealthLeaders Media.
That strategy appears to be changing.

In FY2009, for example, bonds and other fixed income investments averaged 41% of the portfolios of the 86 nonprofit healthcare organizations tracked by the Commonfund Benchmarks Study of Healthcare Organizations. That allocation dropped to 36% in FY2011.

"So we are beginning to see these shifts," Jarvis says. "They don't all occur at once, but it looks as if healthcare organizations are reconsidering whether this endowment model works for them."

Endowment models have been around since at least the early 1990s and Jarvis says they generally have a "higher tolerance for less-liquid assets like real estate, hedge funds, private equity, and venture capital." Higher education institutions, for example allocate about 10% of their investments to bonds.

"Colleges and universities were the leaders in diversifying portfolios into different asset classes that would provide uncorrelated sources of return that don't go up and down together at the same time," Jarvis says.

The endowment model eventually caught on with charitable foundations, then operating charities such as museums and symphonies, and now it is piquing interest with nonprofit healthcare organizations.

Jarvis says that nonprofit healthcare organizations' historical attachment to fixed income investments stems from a reliance on bonds to fund capital projects. "So the rating organizations like to see a large chunk of bonds and cash to maintain the bond rating," he says. "It has been something of a drag on returns and hasn't really protected them in the downturn."

In FY2008, for example, Commonfund reported investment losses averaging 21.2% for the nonprofit healthcare organizations that it tracks. . So that the big shift that we saw this year was healthcare organizations beginning to maybe take a closer look at adopting more closely this endowment model," he says.

With the shift away from fixed-income securities, investments in private capital and real estate have grown from 15% of the average healthcare portfolio in FY2009 to 21% in FY2011, Commonfund analyses show.    

"Normally you don't see moves that big," Jarvis says. "That was funded by taking domestic equities down from 24% to 20% of the overall pool. So that is part of the big news here. Historically we have not seen these kinds of big moves in healthcare organization portfolios. Now we are beginning to see more strategic moves. They don't all occur at once but it looks as if healthcare organizations are reconsidering whether this endowment model works for them."

A Commonfund review of FY2011 also found that:

• After two years of double-digit gains, the 86 nonprofit healthcare organizations it tracks reported investment returns of zero in FY2011. The flat returns followed net gains of 10.9% in FY2010 and 18.8% in FY2009.
• From FY2009-2011 the average annual net return on investable assets was 9.6%, while for the trailing five years annual net returns averaged 1.8 percent – thanks to the -21.2% loss recorded in FY2008 in the midst of the recession.
• A further breakdown for FY2011 shows that net returns on nonprofit healthcare organizations' defined benefit plan assets averaged 1.3% compared with FY2010 net averaged return of 12.3%. Three-year defined benefits plan returns averaged 11% and five-year returns averaged 2.2%.
• By asset class fixed income provided the highest return in FY2011 with an average of 5.4%, followed by a 3.9% return for alternative strategies, 0.2% for short-term securities/cash, -0.2% for domestic equities and -10.9% for international equities.
• Within alternative strategies the highest returns came from private equity real estate at 14.1%; venture capital at 11.1%; and private equity at 10.7%. Marketable alternatives, which include hedge funds, were the largest single alternative allocation for many healthcare organizations and lost -1.8%.
• For FY2011, investment returns were correlated to size; the larger the organization, the better the return. Organizations with investable assets over $1 billion realized an average return of 0.6% while the smaller organizations at the opposite end of the size spectrum lagged with a return of -1.9%.

See Also:

Not-for-Profit Hospitals Show Stability in a Challenging Market