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U.S. NONPROFIT HEALTHCARE ORGANIZATIONS REPORT LOWER AVERAGE TOTAL RETURN OF 6.3% FOR FISCAL YEAR 2005 ON OPERATING FUNDS

Commonfund Benchmarks Study^® Healthcare Report 2006 shows continued drop in Domestic Equities and Fixed Income allocations; increases in Alternative Strategies, International equities and Cash; Gifts and Donations sizes grew an average 111%; Average Total Debt decreased

WILTON, CT, August 8, 2006 – U.S. nonprofit healthcare organizations reported an average total return of 6.3% on Operating Funds in Fiscal Year 2005, according to the Commonfund Benchmarks Study® Healthcare Report 2006 (CBS Healthcare). This was down from an average 8.2% reported in FY 2004 and 14.1% reported in FY 2003. Institutions in all size categories reported lower returns. The largest institutions with total assets of over $1 billion reported an average total return of 7.2% vs. 9.9% the previous year. For most institutions, operating pools include insurance reserves, endowment/foundation assets, reserves, working capital and other assets. Funded depreciation asset reserves continue to be the largest category of assets not included in operating funds.

Three- and five-year average returns on Operating Funds were 10.5% and 4.9% respectively, up from 6.3% and 4.0% the previous year. The average total return reported for Defined Benefit Pension Funds was 7.7% vs. 10% in FY 2004 and 18.1% in FY 2003. However, three- and five-year DB returns jumped up to 13% and 4.6% respectively vs. 6.9% and 4.0% the previous year.

“The investment performance of nonprofit healthcare organizations in 2005 shows that hospitals, healthcare systems, HMOs and others are making prudent changes to deal with a complex and uncertain economic environment,” said John S. Griswold, Executive Director, Commonfund Institute. “Organizations continue to diversify into alternative strategies not correlated with the equity markets. Significantly more respondents reported increases in investment income as a percentage of net income in this year’s study; the size of gifts and donations increased an average 111% for total institutions and even more for smaller organizations; and average total debt decreased for all institutions.”

This fourth annual CBS Healthcare study focuses on the management, investment and operational practices of 202 nonprofit healthcare organizations with a total $105.8 billion in Operating Funds and $45.4 billion of Defined Benefit Pension Funds for the period ended December 2005. Twenty percent of the organizations reported more than $1 billion in total assets. Healthcare organizations provided data on their investment assets including Operating Funds and Defined Benefit (DB) Pension Funds. This study joins the annual Commonfund Benchmarks Study of Educational Endowments and the Commonfund Benchmarks Study of Foundations and Operating Charities.


Operating Fund Performance
CBS Healthcare participants reported an average total return on Operating Funds of 6.3%. Returns varied by size, ranging from an average 7.2% at the largest organizations to 5.9% at midsize organizations with total assets of $501 million - $1 billion.




Seventy-two percent of all institutions and 85% of the largest organizations maintain Defined Benefit pension plans. The average total return reported for Defined Benefit Pension Funds was 7.7% vs. 10% the previous year. The largest organizations reported an average return of 7.4% vs. 11.1% the previous year, and there was an increase to 8.1% vs. 6.5% for the smallest organizations with total assets of $51 million -100 million. Three- and five-year returns for all institutions were 13% and 4.6% respectively, up from 6.9% and 4.0% the previous year. Twenty-one percent of all organizations, and 32% of the largest institutions, have closed or expected to freeze their DB plans. Eighty-one percent of total institutions have established Defined Contribution plans, including 90% of the largest organizations.

The average FY 2005 operating margin reported was 4.6%, and a high of 5.6% among institutions with total assets of $501 million - $1 billion. For total organizations, investment income represented an average 43.5% of net income. Forty-three percent of all institutions and 57% of institutions with $501 million - $1 billion reported increases in net income represented by investment income, thirty percent of total institutions reported decreases, and 18% reported no change. Operating expense budgets averaged $892 million for all organizations and $2.4 billion for the largest institutions. Capital budgets came in at an average $89 million for all organizations and $296 million for the largest institutions.

Eighty-two percent of respondents said they rebalanced their portfolios in FY 2005, up from 77% the previous year. Rebalancing was highest at 87% for organizations with total assets of $501 million - $1 billion and 73% for the smallest organizations. Institutions rebalanced most often “as needed” (49%), followed by quarterly (19%), annually (14%), semi-annually (8%), monthly (7%) and other (3%).

The predominant method used was a fixed mechanism to rebalance to target range, followed by tactically flexible, cash/gift flow changes, calendar method and other. Twenty percent of the largest organizations reported the use of portable alpha strategies, and another 20% of large organizations said they plan to begin using them in the next two years.

Asset Allocations
There was a continued shift of asset allocations out of domestic equities and fixed income and into alternative strategies and international equities in FY 2005. Within operating fund assets, institutions in all size categories reported decreases in dollar-weighted allocations to domestic equities (30% vs. 34% the previous year) and fixed income (34% vs. 41%). Most organizations reported increases in allocations to alternative investments (15% vs.10%), international equities (12% vs. 10%), and cash/short-term/other (9% vs.5%). However, the smallest institutions with total assets of $51 million – 100 million reduced allocations to alternative strategies (6% vs. 9%) and cash/short-term/other (7% vs. 11%). Ninety-five percent of total organizations have an investment policy that includes target allocations by asset class.



Within domestic equity, dollar-weighted allocations among all organizations were large cap (57% vs. 58% the previous year), followed by small cap (17%), index - passive/enhanced (14%), mid cap (10%), and other (2%). Nineteen percent of organizations plan to decrease domestic equities, and 32% of the largest organizations plan to decrease domestic equities. Ten percent of total institutions said they plan to increase domestic equities.

Allocations to fixed income for total institutions were domestic bonds (86% vs. 96% the previous year), global bonds (5% vs. 1%), international bonds (1%), high yield bonds (1%), and other (8%). Multi-strategy bond funds are popular, with an 8% allocation within fixed income. Twenty-one percent of all participants reported they expect to decrease fixed income allocations, including 29% of the largest organizations, and 27% of institutions with total assets of $501 million - $1 billion.

Within international equity, Active MSCI ex-U.S. (developed) represented an average 78% of allocations in this asset for total organizations vs.85% the previous year, and was the highest at 86% for institutions with $101 million - $500 million. Passive/index MSCI ex-U.S. (developed) was 5% vs. 6% the previous year. Emerging markets allocations rose to 17% vs. 7% for total institutions. Eighteen percent of total institutions and 27% of the largest organizations said they expected to increase allocations to international equities in 2006.

Alternative Strategies: Allocations to Hedge Funds Decline
Within alternative strategies, hedge funds remained the largest category of dollar-weighted allocations for Operating Funds. However, average allocations to Marketable Alternatives/Hedge Funds by total organizations dropped to 58% vs. 73% the previous year. The highest allocations to hedge funds were 75% for the smallest institutions with assets of $51-100 million. Hedge fund strategies reported used most by total institutions were: fund-of-funds (used by 82% of respondents), absolute return (33%), long/short equity (31%), multi-strategy (27%), equity market neutral (17%), merger arbitrage (16%), convertible arbitrage (15%), fixed income arbitrage (13%), distressed debt (13%), global macro (10%), private equity/LBOs (6%), venture capital (5%) and other (4%). Long/short equity and absolute return hedge funds were reported used by 59% of the largest institutions.

Seventy-eight percent of organizations’ hedge fund allocations on average are placed through direct investments, and 22% are placed through fund-of-funds. One hundred percent of the smallest organizations use hedge fund-of-funds, as do 85% of institutions with assets of $101-500 million, and 80% of institutions with assets of $501 million -$1 billion.

Other alternative strategies allocations included Private Equity (13% vs. 5% the previous year), Venture capital (4% unchanged from the previous year), Private Equity Real Estate (6% unchanged), Public Equity Real Estate/REITs (6% vs. 5%), Energy & Natural Resources (6% unchanged), and Distressed debt (7% vs. 1%). Twenty-seven percent of total institutions reported they expect to increase allocations to alternative strategies, including 44% of the largest institutions.





Gift Flows and Debt
Thirty-five percent of all respondents reported increases in gifts and donations, including 63% of the largest institutions, and 39% of institutions with total assets of $501 million-$1 billion. The average increase in gift size for these respondents reported was 110.9%. Forty-six percent of total organizations reported no change in gifts and donations, and 13% reported a decrease. Among those experiencing a downturn, the average decrease was 31.6%.


Average debt for total institutions reported was $395 million vs. $413 million the previous year. Thirty-two percent of participants reported an increase in debt, 33% a decrease, and 36% no change in debt. The biggest reductions occurred among the largest institutions, which reported average debt of $1.1 billion vs. $1.5 billion the previous year. Among all other institutions, average debt increased or remained flat year to year. Overall, 39% of total institutions and 53% of institutions with assets of $501 million -$1 billion said they expect to increase debt. For all institutions, 66% of debt is fixed rate, 34% is variable, and 44% is swapped or hedged.

Corporate Governance, Management and Operations
One-half of the organizations (50%) participating in the Study said they maintain a proxy voting policy, including 78% of the largest organizations and 36% of the smallest organizations. Ninety-one percent of total institutions reported having a conflict of interest policy. One-half (50%) of institutions allow board members to do business with the organization. In many cases, individual board members are prohibited from doing business with the organizations, but their firms are not.

Forty-one percent of respondents (83 organizations) reported having policy restrictions on certain types of investments. Investment restrictions include: tobacco (prohibited by 95% of total institutions and 100% of the largest), alcohol (39%), firearms/weapons (25%), pornography (22%), abortion (19%), gambling (17%), birth control (13%), other (11%) cloning (10%), unfair labor practices (7%), environmental protection (6%), and animal welfare (1%). However, only 49% of organizations said they vote proxies consistent with their investment restriction criteria.

A relatively small number of organizations said they discuss critical accounting and investment issues with their auditors. These issues included impairment of investment issues (57% of total institutions), FASB 133/derivatives accounting (50%), valuation of private equity/hedge funds (46%), and audit dates for these funds (32%).

Institutions of all sizes except the smallest organizations increased the number of investment firms used in FY 2005. Total institutions increased the average total number of investment firms to 13 vs. 11 the previous year. The largest organizations increased their investment managers to 26 vs. 23. Most of these increases involved the hiring of managers for alternative strategies. The average number of alternative managers used by total institutions increased to 12 vs. 2 the previous year. The largest institutions increased alternative managers to 27 vs. 9 the previous year. Looking ahead, organizations plan to hold the number of managers they use at approximately the same current levels for the next three years.

Healthcare organizations’ investment committees included 8 to 9 members on average, and larger organizations appear to attract a greater number of investment professionals. Investment committees meet between four and five times per year on average.

Investment staffing remains lean, but is rising. Total institutions reported an average 1.3 FTEs vs. 1.0 FTEs the previous year. The largest organizations reported 3.4 FTEs vs. 2.3 FTEs. Overall, the use of consultants increased modestly to 85% of total institutions vs. 82% the previous year. Consultant use dropped for the largest and smallest organizations, but rose to 96% vs. 90% for institutions with total assets of $501 million-$1 billion. Organizations that employ consultants use them for asset allocation models, manager selection/evaluation and performance measurement; and to a lesser extent for record-keeping. Seventy-four percent of total organizations reported they have a conflict of interest policy for consultants.


* To request a copy of the full report please email cf_orders@cfund.org.

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Founded in 1971, Commonfund is devoted to enhancing the financial resources of educational and other nonprofit institutions including endowments, foundations, healthcare and service organizations through superior fund management, investment advice, and treasury operations. Directly or through its subsidiaries, Commonfund Capital, Commonfund Realty, and Commonfund Asset Management Company, Commonfund manages approximately $37 billion for more than 1,600 educational institutions, foundations, healthcare and other nonprofit institutions, representing one of the largest pools of educational endowment and operating funds in the world. In response to the growing needs of nonprofit institutions, Commonfund, together with its subsidiary companion organizations, offers more than 45 different endowment investment programs including funds for the management of short- and intermediate-term operating cash reserves. All securities are distributed through Commonfund Securities, Inc.
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