Hospitals and health systems in a new regime

Quick Convos – Healthcare Peer Risk Insights

Calvin: Hi Anne Marie – I have a question about Healthcare investing, could we catch up over coffee?

Anne Marie:  Absolutely  

Calvin: I hear you just launched your fiscal year 2021 peer risk study for healthcare balance sheets.  Can you give me a quick overview of what it is?  

Anne Marie:  Sure Calvin!  I actually have a recent presentation with me, let me pull it up

Our peer risk study aims to spark dialog around how hospital systems are investing - how they are allocated, how much risk and the types of risk they are taking, and how those choices may perform under stress scenarios and growth scenarios. 

We take an enterprise view, leveraging data from public financial statements of 50 US hospitals to provide an in-depth analysis for each system.  We can also customize the peer group and add systems on an ad-hoc basis too.

Calvin:  Cool.  So what asset allocation trends are you seeing in the latest study?  

Anne Marie:  Calvin, the most notable and understandable shifts have been changes in cash and short-term liquidity.

In fiscal year 2019, a 10% average enterprise allocation to cash was typical relative to balanced exposures across fixed income, equities, and alternatives.

In fiscal year 2020, cash levels swelled as hospitals built up defensive liquidity from CARES grants, Medicare Advances, and issued debt and opened lines of credit. 

In fiscal year 2021, cash and fixed income levels started to come back down as both operations and markets stabilized, and Medicare Advances began to be repaid.   We also see combined exposure to risk assets like equity and alternatives edging up as valuations rose in 2021.

However, 2022 is shaping up to be a significant challenge.  With expenses up 15-20% for many systems, it's been difficult for operating cash flows to keep pace.   We could see cash levels lower.  And with this year’s market sell off, we would expect lower public allocations but higher private allocations as those valuation changes lag.

Calvin:  Yeah, with this year’s historic market drawdown, I’d imagine how much risk and the type of risks you’re taking really mattered.  So what does the risk profile of a hospital systems look like?

Anne Marie:  The 50-60% allocations to equity and alternatives drives nearly all the risk for most hospital portfolios.  Fixed income – which is interest rate risk and spread risk - has been providing very little downside protection.  Some hospitals who diversify their fixed income exposure in both public and private credit benefit from spread risk diversification. 

On the flip side, alternatives can be a good source of diversification, especially hedge funds, private credit, and infrastructure, which are among the most risk efficient asset classes in our capital markets framework. 

When we compare system level expected risk vs. expected return, we do generally see those more diversified systems generating more return for the risk taken relative to peers.

Calvin:  So I understand investments are really important to the financial strength of hospitals.  So how do hospital system portfolios perform under stress?

Anne Marie:  That’s an important question Calvin.  

Anne Marie:  We see that in historical scenarios, like the Crash of 2008 or the Covid drawdowns in 2020, the instantaneous drawdown ranges from the mid-teens to the mid-twenties percentages. 

Unfortunately, that also sounds a lot like the current period.

So the risk appetite of a lot of systems is being tested right now when you look at the impact on key financial strength metrics, like Days Cash on Hand or Cash to Long Term Debt.  Debt covenants are a near term concern for some, and balance sheets may be tested by both prolonged market and operating pressure. 

Calvin: It sounds like a dialog about maximizing returns for a hospital’s preferred level of risk is really important right now.   
So thanks for this chat!  A lot of hospital systems have been asking about this topic, so let’s set up meetings to take them through a customized peer study!

Anne Marie:  That sounds great Calvin!

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