Riskier Investment Strategies for Hospitals Could be Slippery Slope

According to a study recently published by the Commonfund Institute, not-for-profit hospitals throughout the United States are turning to riskier investment strategies in alternative assets as a means to make-up for the losses they incur from government reimbursement cuts.  The 2012 Commonfund Benchmarks Study® of Healthcare Organizations evaluated the investments and returns in FY 2011 of approximately 86 not-for-profit healthcare organizations, and compared them to previous benchmarks from the past three years.

The Study concluded that the participating healthcare organizations reported 0% returns on their investments in FY2011.  The Study went on to report that, “The flat returns followed net gains of 10.9% in FY2010 and 18.8% in FY2009 [...] Beyond the flat year-over-year return, the most important shift to emerge from the Study was in asset allocation, where healthcare organizations’ allocation to alternative investment strategies in their investable asset pools grew to an average of 21 percent in FY2011 from 17 percent in FY2010. This increase in the allocation to alternatives appears to have been funded by a decreased allocation to domestic equities, which declined to 20 percent in FY2011 from 24 percent in FY2010.”

While the highest returns came from fixed income assets, the next highest asset class was alternative investments, which includes real estate, hedge funds, private equity and venture capital investments.  And with approximately 21% of hospitals’ assets being invested in these alternative investments, we can only speculate as to the potential impact this could have on hospitals’ risk exposure in the future.  Moreover, one can just imagine the potential consequences or fallout that could likely result for these organizations, as this shift towards riskier investment assets results in further market instability and possible negative returns down the road, as we have seen many times in the past and especially throughout the most recent market downturn.

According to the conclusions in the Commonfund study, the most significant factor influencing this evolution towards hospitals investing their capital in riskier assets is the growing burden of reimbursements cuts and the impact that has on hospitals’ growth.  As margins are being pinched tighter every time the government makes any sort of change on healthcare, hospitals have to figure out new and more innovative ways to maximize returns on their capital.  Often times, this means pursuing riskier strategies, which can hit big when they hit; however, in today’s post-recession environment, there are many more negative connotations associated with investing in riskier alternative assets.

Perhaps more importantly, though, we should look at how this trend from the past few years could be extrapolated and incorporated into projections for how investment and capitalization strategies might look in the future.  If the federal government continues to cut reimbursement, which another report released in the past two weeks stated that providers could experience cuts well over 20% next year, how will this continue to influence the investment strategies for these organizations?  As margins become thinner and the pressure on maximizing capital returns as a means of staying alive becomes more of a reality for these organizations, how will this affect the risk profile that hospitals are willing to accept.

Not to sound like a full-fledged pessimist, but if we fast-forward 5-7 years beyond 2012 and consider how this flight to risk ultimately unfolds, we could potentially be looking at a major bubble.  This bubble will not form like tech in the late 1990’s or mortgages in the mid-2000’s, where the risk profile broadened due to a flood of capital entering the market, which put pressure on assets to perform more competitively.  Meaning, the competition was so significant that asset managers could not settle for 15% growth in asset values, or even 20%-25% returns.  This drove asset values up to highly inflated levels, which ultimately resulted in a bubble bursting, due to the overwhelming imbalance of market fundamentals combined with a range of other variables affecting volatility and valuations.

On the contrary, this bubble involving healthcare assets could be forming as a result of organizations seeking riskier alternatives that may potentially yield the kind of returns they need to actually maintain any growth at all.  Simply put, these organizations are seeking greater risk, because it will ultimately be the only option that yields any results at all.  At 0% investment returns in 2011, this does not give hospitals much room to grow or expand.  Moreover, as they have to pursue riskier investments the following year as a way to even get 1%-5% growth, the stress on the market if and when asset values decline could be catastrophic.  Meaning, once hospitals start losing money on these assets, we will not be talking about cutting bonuses for CEOs of Wall Street investment banks.  Instead, we will be talking about which hospitals will have to be closed and how many jobs will be cut from some of the largest employers in markets throughout the country.

When healthcare reform comes up as a political discussion or on a campaign stop, it tends to go straight towards the arguments around providing care for the millions of uninsured Americans and providers compromising, so that access becomes pervasive throughout society.  However, this is not the reality of this discussion.

The reality is that when the system has reached a point of being so drastically inefficient that organizations are having to invest in hedge funds and venture capital assets simply to prevent losing money and cutting back their services, we can forget about expanding care to the uninsured or improving quality medical services for all.  Because when this bubble bursts, it will not be resolved by talking about providing insurance for everyone or improving quality in all medical services.  This will create an avalanche of problems in our healthcare system that neither candidate or party is prepared to address.

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Mark Reiboldt is an economist and investment banker at Coker Capital Advisors, a healthcare-focused investment bank headquartered in Atlanta, Georgia.  He can be reached at markreiboldt@cokercapital.com.

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