Capital Finance

William F. Jarvis

A nationwide study of healthcare organizations shows flat returns as well as some important shifts in asset allocation for investable assets and defined benefit plans.

If, at the time of your annual physical, you tell your physician that you have been on the treadmill for a year, you'll probably be roundly praised for your dedication to physical fitness. But if you are a healthcare organization's CFO or a member of the investment committee, having to report that your organization's investment returns have been on a treadmill for a year will likely yield a much less enthusiastic response.

Unfortunately, that is essentially the story of FY11's investment performance for the 86 healthcare organizations contributing data to the 2012 Commonfund Benchmarks Study® Healthcare Report. The study, which has been published annually since 2003, is a survey of not-for-profit healthcare organizations' investment, financial, and governance practices. This year's report, for the period Jan. 1, 2011-Dec. 31, 2011, shows that these 86 organizations indeed spent the year on a treadmill, earning a negligible net return of 0.03 percent.

Long-term Returns on Assets

Longer-term returns were more heartening. For the trailing three years, the average annual net return was 9.6 percent, while for the trailing five years, annual net returns averaged 1.8 percent. The three-year period included 2009 and 2010, years of strongly recovering markets when participating organizations reported average returns of 18.8 percent and 10.9 percent, respectively. The trailing five-year returns reflect the -21.2 percent results registered in 2008, when the financial crisis was most severe.

FY11 returns for organizations' defined benefit (DB) plans were somewhat better than those for the investable asset pool, averaging 1.3 percent net of fees. Three-year and five-year net returns averaged 11.0 percent and 2.6 percent, respectively.

The study separates data from the 86 participants into four size cohorts with respect to investable assets:

  • Over $1 billion
  • $501 million to $1 billion
  • $251 million to $500 million
  • Below $251 million

For FY11, investment returns were correlated with asset size: The larger the organization, the higher the return. Organizations with more than $1 billion in investable assets realized an average return of 0.56 percent, while organizations at the opposite end of the size spectrum lagged with a return of -1.99 percent. In total, the 86 organizations represented investable assets of $99.8 billion and $42.4 billion in DB plan assets. ("Investable assets" includes endowment/foundation funds, funded depreciation, working capital, and other separately treated assets.)

For the trailing three-year period, the smallest organizations-those with investable assets under $251 million-realized the highest average annual return on investable assets, 10.4 percent, which was an annual 50 to 160 basis points higher than the other three size cohorts and reflected the strong performance of domestic and international public equities during the FY09-10 market recovery. For the trailing five years, the next largest group-organizations with assets between $251 million and $500 million-produced the highest annual return, an average of 2.4 percent. This return was 60 to 80 basis points annually ahead of that of the other three size categories.

For DB plan assets, organizations with assets of more than $1 billion had the best 2011, posting an average return of 2.3 percent. This was well ahead of the 0.6 percent return reported by organizations with assets between $501 million and $1 billion.

Asset Allocation

Turning to asset allocation, the study population's response regarding its investable assets and DB plan assets on a dollar-weighted basis as of Dec. 31, 2011, is shown in the exhibit below, with the FY10 allocation in parentheses.

What stands out in the FY11 asset allocation figures is the significant shift away from traditional domestic equities and toward alternative investment strategies, which include hedge funds, absolute return, market neutral, long/short 130/30, event-driven, and derivatives. Healthcare organizations thus join an ongoing trend that has been observed in the investment practices of educational institutions, foundations, and operating charities and documented in parallel studies of these sectors.

Although healthcare organizations' allocations to alternative strategies, in the range of 20 percent, are still far below the 51 percent average allocation reported in the most recent study of colleges and universities, it is nevertheless significant that healthcare organizations are now putting in place an investment structure that more closely resembles the "endowment model" used by other types of not-for-profits. Healthcare organizations' allocations to fixed income, in the mid- 30 percent range, remain high compared with those of other types of not-for-profits; at colleges and universities, this allocation is just 10 percent, while at operating charities, it is 22 percent.

Exhibit 1


Operating Data

Turning to operating data, participating healthcare organizations reported an average expense budget of $1.52 billion and an operating margin of 4.1 percent, the same as in last year's study. Reflecting FY11's flat investment returns, median investment income as a percentage of net income declined to 28.7 percent from 50.0 percent in FY10. Participating organizations' capital budgets contracted significantly in 2011, falling to an average of $99.9 million from $143 million in FY10. This decline, which was accompanied by a concomitant fall in average debt outstanding, from $1.0 billion in FY10 to $723 million in FY11, may reflect the ongoing deleveraging trend that is apparent as organizations continue to grapple with the difficult economic environment. The advantages of scale are also apparent: While organizations with assets over $1 billion averaged $173.3 million in capital spending in FY11, organizations with assets under $251 million invested an average of just $8.2 million.

With this in mind, debt ratings continue to influence asset allocation and investment practices. Forty-five percent of participating organizations reported having the highest or high grade debt ratings, while another 36 percent reported having an upper medium grade rating. Larger organizations were most likely to have debt ratings, while more than one-third of the smallest organizations reported having no rating at all-an indication that their modest capital expansion budgets are being financed by means other than debt.

In previous columns, we have noted the changing financial and investment dynamics that are buffeting healthcare organizations of every size, and have called for a reassessment of the traditional portfolios used by most institutions in the sector. This year's data indicate that the leading organizations are indeed making changes in asset allocation that, we hope, will lead to higher long-term returns and strengthened mission support throughout the sector in coming years.

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


Publication Date: Monday, September 03, 2012

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