Contact:

John S. Griswold Jr. Commonfund Group     203-563-5030 jgriswol@cfund.org

Contact:

Geoff Phelps Roy Chernus The Sherry Group (973) 984-3000 gphelps@sherryllc.com rchernus@sherryllc.com

U.S. NONPROFIT HEALTHCARE ORGANIZATIONS REPORT LOWER AVERAGE TOTAL RETURNS FOR FISCAL YEAR 2004

Commonfund Benchmarks Study® - Healthcare Report 2005 Shows Organizations' Returns Down but still positive; Hedge Fund investments Increase at the expense of Private Equity and Most Institutions expect to increase Alternative Strategies in 2005

WILTON, CT, September 9, 2005 – U.S. nonprofit healthcare organizations reported an average total return of 8.2 percent on Operating Funds for Fiscal Year 2004 according to the Commonfund Benchmarks Study® Healthcare Report 2005 (CBS Healthcare). This compares with an average total return of 14.1 percent reported in FY 2003. Three- and five-year returns were 6.3 percent and 4.0 percent respectively. The average total return reported for Defined Benefit Pension Funds was 10.0 percent, compared with 18.1 percent reported for FY 2003. Three and five-year returns were 6.9 percent and 4.0 percent respectively. The average budgeted return assumption reported for FY 2005 was 5.5 percent for Operating Funds. The average actuarial assumption for expected returns on Defined Benefit Pension Funds for the same period was 7.7 percent.

“The more modest investment performance of nonprofit healthcare organizations in 2004 shows that hospitals, healthcare systems, HMOs and others are still dealing with a complex and uneven financial environment,” said John S. Griswold, Executive Director, Commonfund Institute. “While most asset allocations changed little last year, alternative strategies grew, there was a significant increase in hedge fund investments from private equity, and more than half of all respondents and nearly two-thirds of the larger organizations reported increases in investment income as a percentage of net income.”

This third annual CBS Healthcare study focuses on the management, investment and operational practices of 197 nonprofit healthcare organizations with $91 billion in Operating Funds and $37 billion in Defined Benefit Pension Funds for the period ended December 2004. Healthcare organizations provided data on their investment assets including Operating Funds and Defined Benefit (DB) Pension Funds. The study joins the annual Commonfund Benchmark Study of Educational Endowments and Commonfund Benchmark Study of Foundations. 

Operating Fund Performance

CBS Healthcare participants reported an average total return on Operating Funds of 8.2 percent.  Returns varied by size, ranging from 9.9 percent at larger organizations (operating funds of $501 million or more) to 7.3 percent at smaller organizations (operating funds of $500 million or less).

Average Annual Total Return* on Operating Funds for FY 2004
 

* (%) Percent                    CBS 2004/204 organizations

The average total return reported for Defined Benefit Pension Funds was 10.0 percent. Larger organizations reported average returns of 11.1 percent vs. smaller organizations with 6.5 percent. However, smaller organizations reported the strongest returns for the three- and five-year periods.

The average FY 2004 operating margin reported was 4.9 percent, and was higher among larger institutions than smaller ones. Institutions reported that investment income represented an average 37.8 percent of net income, ranging from 48 percent among larger organizations to 17.7 percent among smaller ones. The average percentage of operating assets transferred to the operating budget or capital budget was 9.5 percent of operating pool value. Smaller organizations reported a higher percentage of operating assets transferred than larger organizations.

Almost all (92 percent) of organizations report they have target or policy portfolios. Seventy-seven percent of respondents rebalanced their portfolios in the past year, ranging from 91 percent of larger organizations to 55 percent of smaller organizations. This compares with 84 percent of all respondents rebalancing in FY 2003. Institutions rebalanced most often “as needed” followed by quarterly and annually. The predominant method was via a fixed mechanism to rebalance to target range, followed by tactically flexible and/or cash/gift flow changes.

Asset Allocations

There were subtle changes to asset allocations for Operating Funds compared with the previous year. Within total operating fund assets, respondents reported allocations to domestic equities (34 percent vs. 37 percent in FY 2003), fixed income (41 percent vs. 39 percent), international equities (10 percent vs. 9 percent), alternative investments (10 percent vs. 8 percent), and cash/short-term/other (5 percent vs. 7 percent). DB Pension Fund asset allocations saw modest reductions in domestic equity and fixed income, and a slight increase in international equity. The DB Pension Funds asset mix was domestic equity with 47

percent; fixed income with 28 percent, international equity with 15 percent, alternative investments with 9 percent, and cash/short-term/other with 1 percent.

Within domestic equity, organizations reported Operating Fund allocations to large cap (58 percent vs. 54 percent in FY 2003), mid cap (11 percent vs. 14 percent), small cap (17 percent vs. 15 percent), and index (14 percent vs. 17 percent). DB Pension funds reported increased allocations to large cap (65 percent) and small cap (6 percent), at the expense of allocations to mid cap (18 percent) and indexed equities (11 percent).

Overall, organizations reported no changes in Operating Fund allocations to fixed income. The asset mix was domestic bonds with 96 percent, global bonds with 1 percent; international bonds with 1 percent, and high yield bonds with 2 percent. DB Pension Funds’ asset mix was domestic bonds with 92 percent, global bonds with 5 percent, international bonds with 2 percent, and high yield bonds with 1 percent.

International equity asset mix for Operating Funds was largely unchanged from the previous year: Active MSCI with 85 percent, Passive MSCI with 6 percent, and Emerging Markets with 9 percent. There was a modest shift from passive to active MSCI ex U.S. (developed). DB Pension Funds’ asset mix also was similar to the previous year: Active MSCI with 86 percent, Passive MSCI with 7 percent, and Emerging Markets with 7 percent.

Alternative Strategies Allocations Grow at Expense of Private Equity

Within alternative strategies allocations for Operating Funds, larger organizations reported a move to Marketable Alternatives (Hedge Funds), with most of the shift coming out of allocations to Private Equity. The asset mix was: Marketable Alternatives/Hedge Funds with 73 percent vs. 67 percent in FY 2003, Private Equity with 5 percent vs. 10 percent, Venture Capital with 4 percent (unchanged from FY 2003), Private Equity Real Estate with 6 percent vs. 8 percent, Public Equity Real Estate/REITs with 5 percent vs. 7 percent, Energy & Natural Resources with 6 percent vs. 3 percent, and Distressed Debt with 1 percent (unchanged).

DB Pension Funds reported a similar year-over year shift to Marketable Alternatives from Private Equity. The asset mix was: Marketable Alternatives with 68 percent, Private Equity with 5 percent, Venture Capital with 2 percent, Private Equity Real Estate with 11 percent, Public Equity Real Estate/REITs with 5 percent, Energy & Natural Resources with 8 percent, and Distressed Debt with 1 percent.

Overall, 40 percent of organizations reported allocations to Marketable Alternatives ranging from 59 percent of larger organizations to 26 percent of smaller organizations. Thirty-one percent of organizations reported using funds of funds for these investments. The average Marketable Alternatives allocation invested via funds of funds was 90 percent, ranging from 82 percent at larger organizations to 100 percent at smaller organizations.

Marketable Alternative strategies used included multi-strategy with 72 percent of organizations, absolute return with 51 percent, and long/short equity with 49 percent. Larger organizations more often used all strategies, particularly distressed debt, more often than smaller organizations. Smaller organizations most often reported using multi-strategy. Concerns about Marketable Alternatives investments most often included risk relative to benchmark, followed by liquidity risk. Larger organizations most often cited standard deviation as a concern.  

2005 Expectations

Healthcare organization Operating Funds most often reported expected increases in allocations to alternative strategies and international equities in FY 2005. Larger organizations most often reported expected reductions in target allocations to fixed income and domestic equity, while smaller organizations more often reported expected reductions in cash and short-term investments. DB Pension Funds also reported expected increases in alternative strategies targets, and roughly one-third of larger organizations expect to make this change. DB Pension Funds reported expected reductions in allocations to domestic equities and fixed income, especially among the larger organizations.

Gift Flows and Debt

Forty percent of all organizations reported increased gifts, while almost one-half (49 percent) reported no change in gift flows. Eighty percent of the larger organizations reported increases in gifts, and 20 percent reported no change. Smaller organizations more often reported no change in gifts from the previous year.

Average debt reported was $413 million; larger organizations reported significantly higher amounts of debt on average than smaller organizations. Thirty-eight percent of organizations overall reported increased debt, 35 percent decreased debt, and 25 percent unchanged debt levels. Roughly two-thirds of debt was fixed rate, and one-third variable rate. Smaller organizations reported carrying a higher percentage of fixed rate debt than larger organizations.

Corporate Governance, Management and Operations

More than half of organizations (55 percent) reported having investment restrictions. Of these, 65 percent are socially restricted – a finding significantly more prevalent among the larger organizations. Larger organizations more often reported having governance/proxy voting restrictions than smaller organizations. Forty-five percent of organizations overall, and 63 percent of smaller organizations, report “other” investment restrictions including bond ratings quality, prohibitions on derivatives and hedge funds, state statues and investments in competitor healthcare organizations’ securities.

Professional staffing of the investment function at healthcare organizations remained lean, with participants reporting 1.0 full-time equivalents (FTEs) on average in the investment function vs. 0.7 FTEs in FY 2003. Larger organizations reported larger staffs (2.3 FTEs on average) than smaller organizations (0.3 FTEs on average), which reported fewer FTEs on average than the previous year.

Healthcare organizations reported an average investment committee of 8.3 members, with larger organizations reporting more members on average than smaller organizations. An average 3.0 members of the investment committee were investment professionals, and an average 2.1 had specific experience in alternative strategies. Larger organizations reported more members that were investment professionals and had alternatives experience than smaller organizations.

Thirty-five percent or organizations reported they had term limits for investment committee members. The average term length was 3.8 years.

Healthcare organizations reported using 11 separate firms on average to manage their investment portfolios. For all but the largest organizations, the greatest number of managers is for domestic equity investments. At the largest organizations, the largest number of managers are used for their direct investments in Marketable Alternatives (hedge funds). Modest growth in manager use is expected over the next three years. Organizations reported they expect to use 12 separate firms on average to manage their investment portfolios. The largest organizations expect to use 27 separate firms on average, up from 23 in FY 2004, mostly as a result of additions to managers for direct investments in Marketable Alternatives.

Eighty-two percent of healthcare organizations reported using consultants, down slightly from 85 percent reported the previous year. This reveals an apparent drop in consultant use by the smaller organizations year over year. Consultant use varied by size of organization, with 88 percent of the largest organizations (vs. 92 percent in FY 2003) and 65 percent of the smallest organizations (vs. 80 percent) reporting they used consultants.