Sedlaceks advice for reconciling the short-term nature of humans with the infinite time frames of endowments is summed up in one word: policy. Commonfund offered up two examples of healthcare systems that it believes are doing it right. One is 454-bed West Virginia University Hospitals in Morgantown. David Salsberry, its vice president of finance and chief financial officer, says that although they are separate organizations, WVUHs alignment with West Virginia University has helped it to develop a savvy investment policy. Through a business relationship started in 2002 that WVUH pays for, investment managers at the West Virginia University Foundation give it investment advice.
They have their own policy, and we have our own policy, Salsberry says. Most academic (institutions) have a higher percentage in alternative investments than were comfortable with. I have certain liquidity requirements. Were very cyclical, whereas endowments have little drain on the principal so their liquidity requirements are much less significant.
Through Oct. 31, 2006, WVUH was working with approximately $316 million in assets in its investment portfolio. It was allocating approximately 60% of its $251 million in reserve funds into equity investments and 40% into fixed income. During that same period, the organization earned $12 million in investment income and $8 million on operations on $388 million in total revenue, according to its unaudited statement. Another way of looking at it is the 2% operating margin for the year to date has been boosted to a 5% total margin by investment income. That compares with investment income of $6 million and operating income of $14 million on total revenue of $437 million in 2005, according to WVUHs audited financial statement.
As part of its investment strategy, West Virginia University Hospitals is doing several things differently from other hospitals, but the main thing is it is doing something. Ive found that (hospital) CFOs tend to focus more on budgets and receivables and tend to spend less on investments from a time standpoint, Salsberry says. Id venture to say many community hospitals have investment policies that are either inadequate, not available in some cases or need to be brought up to date.
One perhaps startling difference between WVUH and others: We try to keep our operating cash virtually at zero and push that cash over into investments that have longer-term duration, Salsberry says.
Most hospitals, he guesses, arent sophisticated enough to know their cash needs over the next 30, 60 or 90 days so they are instead sweeping their cash into overnight accounts that offer lesser yields. It takes a level of sophistication on the operating side to project a hospitals cash needs, the fear being you dont want to hang up your money and find out you cant keep payroll, he says.
Up until a year or two ago, WVUH thought the same way, cautious about how much money it had in liquid investments so it could quickly convert an investment to cash if necessary, Salsberry says. What we started to realize was that even equities are convertibleyou can take equity and fixed income and convert it to cash within 90 days if you have to.
Taking a further step back, WVUH realized that it would never need all of its investment reserves, and considered driving its investment strategy not by an allocation formula but by its liquidity requirements. That in turn allowed it to move money into more significant alternative investments which by nature arent liquid but at the same time are less risk, Salsberry says. For example, WVUH is investing some cash in real estate, getting a higher return than it would from a money-market fund.
The revelation was: How much of our cash do we really need to have liquid? Salsberry says. CFOs tend to be very conservative with cash because were all afraid were going to need money. Conscious that diversification lowers risk, officials recognized that by moving cash away from overnight accounts into 90-day vehicles, they were diversifying their portfolio tremendously, he says. Its not the level of investment thats significant; its how an institution is investing that pool of money.
Salsberry says the first stepbuilding a level of sophistication into the finance department to be able to project cash flowmay sound simple, but most community hospitals with fewer than 300 beds are probably not doing it. If you are talking about $20 million in cash at any point in time, that could translate to an additional $100,000 annual return. That may sound like a lot of work for $100,000, he says, But once you start to do it, its pretty simple to do.
Thus the second revelation, Salsberry says, was that WVUH had a lot more liquidity in its equity and fixed income investments than it thought, the only downside being that market conditions may not always be favorable for converting. To counter that, WVUH decided to put more money into investments that arent convertible to cash in a short period of time but have a lower risk and better yield.
We were able to invest in things we would never have invested in because we were afraid of the cash flow, Salsberry says. So WVUHs investments are more diversified and more long-term and, as a result, less risky. So in actuality, when Salsberry says the investments are split 60-40 between equity and fixed income, he is including 41% in equity, 19% in alternative equity investments, 20% in public fixed-income investments and 20% in fixed-income alternative investments.
Return on investment is becoming more crucial, Salsberry notes. The operating margin in an institution as reimbursement continues to get tightened is not sufficient to recapitalize an institution, Salsberry says. You have to pull money out of the investment portfolio. We view our investment assets as one component of our financial management program that is very significant, that will make a difference between what we are capable of doing in the long run.