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.
“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 knee-jerk reactions to the market’s movements.”
Effects on debt ratings
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 not-for-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.
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.”
Tara Bannow covers hospital finance for Modern Healthcare in Chicago. She previously covered all aspects of healthcare for the Bulletin, a daily newspaper in Bend, Ore. Prior to that, she covered higher education for the Iowa City Press-Citizen. She earned a bachelor’s degree in journalism in 2010 from the University of Minnesota.