Healthcare’s next chapter: Key investment themes for CFOs

Healthcare’s next chapter: Key investment themes for CFOs

Throughout the pandemic America's healthcare institutions have faced shocks to operations, disruption of revenue, sharp rises in costs and waves of uncertainty. For many hospitals, these issues were intertwined with a difficult investment landscape and volatile markets. Meanwhile, the past two years have underscored the social determinants of healthcare, healthcare inequity and how essential public health is.

Strong balance sheets and federal relief programs helped most hospitals withstand both the healthcare delivery and financial crisis of the pandemic, but hospital margins continue to be crunched and remain below 2019 levels. As new technologies and treatments promise to improve the healthcare experience dramatically, higher costs—brought on by workforce shortages and rising supply prices—continue to exert pressure on hospital financials and drive CFOs to unlock new sources of resiliency. We’ve identified three key learnings for CFOs to consider for liquidity and investment strategy as they navigate this complex environment.

Bigger bang for your buck

Most CFOs would agree that a sharp market downturn – like we experienced in February and March of 2020 – would constitute a stress event that puts temporary downward pressure on Days Cash on Hand (DCOH). If it’s a protracted market downturn – like we experienced in the Global Financial Crisis – that pressure could turn to credit rating concerns. However, a less obvious enterprise stress is having an investment strategy that is not keeping with inflation, not exceeding the cost of capital, or not generating enough growth to support future capital expenditures.

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Not taking enough investment risk is just as big a risk to the enterprise as taking too much.

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Anne Marie Schultz Head of U.S. and Canada Healthcare Business

The healthcare crisis forced some organizations to re-underwrite enterprise priorities and their targets for them. These conversations among management and Boards have not been easy. There are those who want to manage liquidity, limit volatility and avoid scrutiny by rating agencies or bond buyers. And there are those who want to pursue growth, seize opportunities and tolerate downside risks.

To drive a constructive debate and decisions around questions like how much investment – and enterprise risk to take, we advocate choosing one, two or three key metrics that everyone understands are material to the organization and are sensitive to the strategic choices made in the investment portfolio. They tend to be the obvious and important ones, like DCOH or Cash to Long Term Debt, but less so obvious ones like Net Asset Volatility. While every hospital has its unique blend of challenges and objectives, insights into how peer organizations are positioned for investment strategy, investment risk and these key metrics can help provide context.

Our annual Healthcare Peer Risk Study, which examined the allocations of 30 U.S.-based hospitals and health systems, showed an average enterprise portfolio expected risk of about 9%. That means that stakeholders should expect a dollar invested at the start of the year to end the year within a range of $0.91 to $1.09. Predictably, organizations that were able to bring liquidity levels down to near pre-pandemic levels by the end of 2020, and those with higher allocations to growth assets like public equity and alternatives, land on the higher end of the risk range.

We also found that organizations that take on more risk tend to have more DCOH. Higher DCOH gives organizations greater financial flexibility and gives CFOs confidence to take more investment risk, much of which is attributed to higher returning, less liquid asset classes, like private equity. Those higher returning assets drive higher DCOH, creating a virtuous circle of growth.

Risk taking has its rewards

Source: Days Cash on Hand (DCOH) is calculated as total cash & investment assets in scope divided by operating expense less depreciation and amortization expense over 365. Financial statement data used for each system was sourced from Fiscal Year 2020 Annual Reports.
Risk Source: BlackRock, as of June 2021. Ex-ante risk is defined as annual expected volatility and is calculated using data derived from portfolio holdings, using the Aladdin portfolio risk model. This proprietary multi-factor model can be applied across multiple asset classes to analyze the impact of different characteristics of securities on their behaviors in the market place. In analyzing risk factors, the Aladdin portfolio risk model attempts to capture and monitor these attributes that can influence the risk/return behavior of a particular security/asset. Risk: Monthly Constant Weighted (MTC model) with 248 monthly observations; 1 standard deviation; 1yr horizon. For details regarding the indexes used to represent each asset class, see the “Capital Market and Modeling Assumptions" Exhibit A at the end of this analysis.

Finding the “goldilocks zone” for liquidity

At the onset of the pandemic, hospitals generally averted a liquidity crisis by issuing debt, opening lines of credit and briefly pausing reinvestments and/or new commitments. CARES grants, Centers for Medicaid & Medicare Services (CMS) advances and other government aid also helped.

Two years later, organizations are still trying to find their goldilocks zone for liquidity. Many organizations have held more cash to buffer operating volatility. While operating cash levels still remained elevated at 2021 fiscal year ends, rapidly rising salaries and expenses – and a lingering pandemic – are now pressuring operating margins and cash flows. Some organizations have had to draw down this excess cash, and then some to meet near-term obligations.

Organizations that hold too much cash are paying a steep opportunity cost. Among the institutions in our study, we estimate that the most conservative investors are leaving between six and eight cents of potential return on the table for every dollar they hold in cash, which has been earning next to nothing. Considering that cash takes up 15-30% of enterprise assets, those unrealized returns add up quickly.

Finding the “goldilocks zone” for liquidity

Living with inflation

The recent spike in inflation has impacted both operations (rising costs for labor, supplies and other needs) and investments via eroding preserving purchasing power and dragging on growth.

The impact is real. According to our analysis, a scenario in which inflation and interest rates surge would cause an almost 10% asset drawdown for the average healthcare institution, resulting in a DCOH decline of 29 days. Some institutions would experience a drawdown of as much as 13%.

Living with inflation

Risk: 84% confidence interval, constant weighted monthly observations; 1yr horizon Historical scenarios simulate each plan’s current portfolio through historical time periods. Hypothetical scenarios simulate each plan’s current portfolio through hypothetical large market shocks and geopolitical stresses, with implied shocks. The performance shown is hypothetical, does not represent the performance of any existing portfolio, and does not reflect fees and expenses; if fees and expenses were included, the performance would be lower. It is not possible to invest directly in an unmanaged index. There is no guarantee that any portfolio will perform in this manner under similar scenarios going forward. Please refer to the “Stress Test Scenario Definitions” Exhibit C in the Appendix for additional information.

Today’s inflation environment is anything but hypothetical. BlackRock expects inflation to persist from supply-driven shocks, the war in Ukraine and related energy and commodity shocks, all while central banks work to contain inflation without sacrificing growth and employment.

Read about Healthcare's next chapter
Read about Healthcare's next chapter
Anne Marie Schultz
Head of U.S. and Canada Healthcare Business
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Calvin Yu
Head of the Client Insight Unit (CIU)
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Jacqueline Lapeyre
Member of Healthcare, Foundations and Endowments team
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Sarah Siwinski
Member of the Client Insight Unit (CIU)
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