Non-profit health-care investors take closer look at alternatives

In the face of revenue and operational concerns caused by the COVID-19 pandemic, U.S. non-profit health-care organizations have largely held steady to the long-term asset allocation plans for their endowments and foundations, sources say.

Now that equity markets have rebounded from unprecedented drawdowns experienced in March, however, many of these institutional investors are “looking opportunistically” at increasing their allocations to private asset classes, including private credit, said Paget MacColl, a New York-based managing director and co-head of the Americas institutional client business at Goldman Sachs Asset Management LP. Non-profit health-care organizations are considering making these opportunistic investments while remaining within previously set asset allocation target ranges, Ms. MacColl said.

“Many of the (health-care) systems we cover have bands around their strategic asset allocation, so it’s not so strict and they have flexibility,” should changes like market swings occur, she continued. “They have some flexibility on how to rebalance and how to move that allocation within the band,” or target range.

Health-care investors have also responded to concerns about liquidity in a number of ways in recent months, by either expanding lines of credits or examining how to optimize their cash investments, Ms. MacColl said.

Susan Slocum, the CIO of Children’s Minnesota, Minneapolis, the seventh largest pediatric health system in the U.S., said the non-profit increased its credit lines and liquidated $30 million from its operating pool in late March to double the size of its “working capital” pool, or cash portfolio, to $60 million.

Children’s Minnesota has an investment portfolio with $950 million, which includes $175 million in foundation and endowment assets and the rest in “corporate assets,” that essentially serve as the non-profit’s operating pool, Ms. Slocum said.

If emergency funds were needed at a hospital, “the first layer (to tap) would be working capital (or cash), and if you didn’t think your working capital was enough, like we did, we liquidated $30 million out of our operating pool,” she said.

Children’s Minnesota does not plan to change the asset allocation plan for its investment portfolio, but Ms. Slocum said the investment team is looking at credit-related opportunistic strategies “that are emerging out of the current situation.”

The COVID-19 pandemic has crippled many of the revenue streams of hospitals and health-care systems due to a months-long pause on providing non-essential services and procedures — to prevent the spread of coronavirus, and free up personnel and resources to treat COVID-19 patients.

Some hospitals and health-care systems have estimated that net patient revenue will drop up to 40% over the next several months, a May report by Pavilion, a practice of Boston-based investment consultant Mercer Investments LLC, found.

Several health-care systems’ estimates suggest that a time frame to recover lost net patient revenue will be approximately two years, the report said.

“Expenses incurred due to staffing shortages, the increased cost to source and purchase protective personal equipment and the high level of acuity for hospitals directly impacted by the coronavirus have created a spike in expenses,” the report said.

Yale New Haven Health System has so far not had to tap its $3.5 billion investment portfolio for day-to-day operations costs at any of its hospitals, said Geeta Kapadia, the Philadelphia-based associate treasurer for investments.

New Haven, Conn.-based YNHHS consists of five hospitals, including non-profit Yale New Haven Hospital, the primary teaching hospital for Yale School of Medicine. The health system is affiliated with Yale University and Yale School of Medicine, but is a separate entity.

“From an investment standpoint we haven’t done anything differently, other than ensuring … that our (external) managers are doing what they are supposed to do and our liquidity is what it should be. And that we are ready to act and move if need be,” Ms. Kapadia said.

The investment portfolio consists of $1.1 billion in defined benefit pension plan assets, about $500 million in operating pool assets and a long-term investment portfolio that includes foundation assets totaling $1.9 billion, according to Ms. Kapadia. The $500 million operating pool, which is in 100% fixed-income assets, is the only portfolio managed internally by the team.

While the health system’s asset allocation plans have not changed due to market volatility, the investment team “had consistently been trying to increase and diversify (its) allocations to private capital,” since before the pandemic started, Ms. Kapadia said.

In regard to the health system’s long-term investment and defined benefit portfolios, which have a similar investment horizon allowing the team to mirror manager selection, Ms. Kapadia noted: “I wouldn’t say we’ve made any changes to the amount that we invest, but (we are) looking at what is attractive.”

“That may be allocating more time to managers or spending more time meeting with new managers. Although it hasn’t manifested itself in additional dollars, it has changed the way we allocate our time and resources. And that’s been even more challenging given (the pandemic). I think in general, real estate has been something that we’ve consistently been looking at. There are certain opportunities that may be attractive right now, if you are far enough in the due diligence with certain managers,” Ms. Kapadia said.

In its long term/foundation portfolio, YNHHS has a 50% exposure to long-only U.S. and non-U.S. equities, a 10% exposure to hedge funds and a 40% exposure to other alternatives or private assets, she said.

Christian Grimm, a Minneapolis-based principal at Mercer, said that he has not seen a significant shift in the asset allocation plans of the firm’s clients that are U.S. non-profit health-care organizations with endowment, foundation or operating portfolios. “But (health-care investors) are taking stock of cash on the balance sheet (and) looking at where they can raise money through selling high quality fixed-income (investments), such as Treasuries,” Mr. Grimm said.

While health-care investors aimed to avoid selling equities during the “huge drawdown” in March, since equities have been recovering, Mercer has seen these clients move to long-term asset allocation targets that allow them to consider reducing their exposure to U.S. large cap equities to raise more cash for liquidity needs, Mr. Grimm said.

The S&P 500 index returned -30.8% year to date through March 23, when the stock market bottomed. In comparison, the index returned -2.4% year to date through July 9.

Should there be another wave of U.S. coronavirus cases in the fall, Mercer expects it “would be associated with another sell-off in equities,” which means that institutions would avoid being overweight in equities, Mr. Grimm said.

While many elective procedures have resumed at many hospitals, “it’s widely anticipated that operations will remain somewhat depressed through 2021,” he added.

“Systems are looking really hard at the cash-flow systems they have. Not just in terms of more of the (patient) volume coming back online, but whether more people will come back (for services) without health-care insurance,” Mr. Grimm said.

To provide some cushion against revenue shortfalls in the near term, health-care organizations have taken advantage of the Centers for Medicare & Medicaid Services’ Accelerated and Advance Payment Program, which was expanded in late March to provide emergency funding to health-care providers during the pandemic. Some health-care organizations also plan to defer the employer portion of their Social Security tax payments until 2021 and 2022 under the Coronavirus Aid, Relief, and Economic Security Act passed by Congress on March 27, Mr. Grimm said.

Tyler Cloherty, senior manager and head of the knowledge center for Casey Quirk, a practice of Deloitte Consulting LLP, New York, said there are “clearly disruptions in the core business models” of any institutional investors that have an endowment funding an underlying portion of the organization, such as hospitals or universities. But it remains to be seen just how big revenue holes will be, as this depends on how long the pandemic lasts and its impact, he said.

“They are going to be figuring out cost cutting and how much they want to tap their endowments,” Mr. Cloherty said. “The size of the shortfall is still unknown at this point.”