Here is a statistic that should give pause to any healthcare organization’s finance executive: Based on an asset allocation of 70 percent S&P 500 Index stocks and 30 percent Barclays Aggregate Bond Index bonds—in other words, a classic 70/30 stock/bond allocation—a portfolio with a starting value of $100 in January 1966 would have fallen to a value of $74.20 in December 2012 after adjusting for inflation (Consumer Price Index) and 5 percent annual spending.a

Yes, after a span of nearly five decades, the portfolio—whether investable assets or defined benefit plan funds—would have lost more than 25 percent of its value in real terms.

More disconcerting, healthcare organizations will probably have to become more reliant on their long-term pools of investable assets in the future in the face of declining payments from insurance companies and the government. The challenge is particularly acute at smaller and midsized organizations. Large organizations and networks, with substantial endowments to support their operations, have been better prepared financially to adapt to the more stringent demands of the coming environment and have been successful in reducing costs and tightening their organizational structures.

Small and midsized healthcare providers, however, lack the economies of scale necessary to achieve meaningful cost reduction. These organizations may need to merge or affiliate with other organizations to form more competitive networks. With or without these operational steps, small and midsized healthcare organizations should strengthen their resource base by improving the performance of their endowments.

To accomplish this goal, these healthcare organizations should consider adopting the endowment management model developed over the past three decades by educational institutions and successfully copied by other types of not-for-profit organizations. Doing so will require a shift in asset allocation strategy away from fixed income and cash toward a more diversified and equity-oriented approach.

Paying Dearly for High Levels of Liquidity 

The asset allocations of healthcare endowments have tended to be more heavily weighted to fixed income (36 percent of asset allocations) than the endowments of educational institutions (11 percent) and foundations (13 percent).b This difference is because most health systems make use of leverage—primarily bond issues—to fund brick-and-mortar construction projects and improvements. A successful bond offering depends in large part on the ability of the bonds to earn a high rating from the rating agencies, which consider not only operating cash flow, but also the liquidity of the long-term pools of assets as a potential backstop source of repayments. Indeed, liquidity measures have come to form a key metric in determining bond ratings: The higher the liquidity, the higher the bond rating (usually). Thus, healthcare organizations’ investment choices are strongly influenced by bond rating agency requirements that favor more liquid portfolios.

Educational institutions and foundations are more heavily weighted overall to domestic and international equities and to the relatively illiquid group of alternative strategies (which include hedge funds, private equity, venture capital, equity real estate, natural resources, and distressed debt). For example, based on information from the data sources referenced earlier, healthcare endowments allocated 21 percent of their portfolios to alternative strategies, whereas education and foundation endowments allocated 54 percent and 43 percent, respectively. Healthcare organizations, on the other hand, have lower equity and alternative investment allocations overall, as well as far higher allocations to fixed-income investments.

Healthcare organizations’ reliance on liquidity comes at a cost. It has long been accepted that asset allocation decisions account for the vast majority of the variation in an investor’s portfolio returns and that equities, over the long term, have higher returns than bonds. One important reason for rethinking high fixed-income allocations is that, in a crisis, bonds provide limited protection against portfolio loss, particularly on a forward-looking basis, given today’s low-yield and low-spread environment.

In FY08, at the height of the financial crisis, participants in the Commonfund Benchmarks Study of Healthcare Organizations reported net investment returns of –21.2 percent. Foundations reported a return of –26.0 percent in the same time period, while operating charities reported a nearly identical return of –25.8 percent. Healthcare organizations’ returns were thus 460 to 480 basis points better than those of foundations and operating charities in that single year, but, as a consequence of their bias away from equities, healthcare portfolios consistently have returned less than those of foundations and operating charities. In fact, their cash- and bond-laden portfolios underperformed both of these groups in all but one of the years prior to and following the financial crisis. (See the exhibit below.)



Rating agencies, bondholders, and healthcare organizations have a common interest in seeing the healthcare sector not only survive in the coming period of stress and transition, but also thrive beyond it. To that end, a renegotiation of the strictures on asset allocation and liquidity will be necessary.

Making the Shift

For all of these reasons, healthcare organizations should consider adopting the endowment model. The endowment model has three tenets.

A structural bias toward equities. Equity ownership of assets is the best way to benefit from the fundamental economic growth that is the source of real, long-term returns.

A perpetual time horizon. Long-term investors such as healthcare organizations are best placed to benefit from the time value of investing: The longer an investor is willing to commit capital, the greater the expected return. A corollary to this principle is the ability of long-term investors to exploit market inefficiencies by providing capital to illiquid sectors of the markets, such as through private equity, venture capital, and hedge strategies. 

A high degree of portfolio diversification. Long-term investors work to diversify as much risk as possible, seeking to own efficient portfolios that can maximize risk-adjusted return as well as implementing strategies that can hedge fundamental risks, such as inflation and deflation. There is, both in theory and in practice, a higher long-term return associated with more-diversified portfolios that invest in competent managers implementing less-liquid investment strategies. Fixed income and cash, on the other hand, offer little protection against inflation and, in the current zero-interest rate environment, are exposed to the danger that an increase in interest rates could cause the value of the entire bond portfolio to decline.

In the wake of the financial crisis, thoughtful investors have refocused on the benefits they have derived from a diversified portfolio based on equity ownership of assets, balanced with a need for reasonable liquidity consistent with their institutions’ operating needs and structured to protect against inflation and deflation.

Over the longer term, less-diversified portfolios—whether they contain 70/30 mixtures of traditional equities and fixed income securities, or 44 percent allocations to fixed income securities and cash—cannot maintain their purchasing power after inflation and spending. Healthcare organizations should begin making meaningful changes leading to a higher allocation to equities and alternative investments. Such changes will take years to implement, but—particularly for small and midsized healthcare organizations—the time to start is now. 

William F. Jarvis is managing director, Commonfund Institute, Wilton, Conn. 


a. Ibbotson Associates, Bloomberg. The equity portion of the hypothetical portfolio is based on monthly returns of the S&P 500 Index (12/65-current quarter end), and the fixed income portion is based on monthly returns of the Barclays U.S. Aggregate Index (01/73-current quarter end) and the Ibbotson Associates Long Term Corporate Bond Index (12/65-12/72). Returns for the hypothetical portfolio assume that it is rebalanced to 70/30 annually on 1/1/yy and 5 percent is distributed annually on 1/1/yy. 

b.2012 NACUBO-Commonfund Study of Endowments, 2012 Commonfund Benchmarks Study of Foundations, and 2012 Commonfund Benchmarks Study of Healthcare Organizations.

Publication Date: Wednesday, May 01, 2013

Login Required

If you are an existing member, please log in below. Username and password are required.



Forgot User Name?
Forgot Password?

If you are not an HFMA member and would like to access portions of our content for 30 days, please fill out the following.

First Name:

Last Name:


   Become an HFMA member instead