Tips for investment committees
With the decline of traditional pensions, many hospitals and health systems have turned to 401(k)s and other defined-contribution plans in which workers save and invest through an employer-sponsored retirement vehicle.
Healthcare organizations usually empower investment committees with oversight of their defined benefit plans, but committee members often have inconsistent levels of investment experience. Thus, they need all the advice they can get, especially in the current economy.
Healthcare Finance News asked Scott Schermerhorn, chief investment officer at Granite Investment Advisors, to share his recommendations for strategies that hospital investment committees should consider, whether they are launching a new defined benefit plan for employees or changing an existing one.
Schermerhorn offers the following 11 essential insights:
Draft an investment policy statement. ISPs define the plan’s objectives, identify the permissible asset classes for investment and set forth the criteria for hiring providers, including investment managers and third-party plan administrators. Avoid boilerplate statements; they often fail to address issues such as provider fees or have disconnects between goals and strategies. Once adopted, ISPs should be periodically reviewed and updated.
Set performance metrics. Benchmarks should be aligned with the plan’s objectives and asset allocation, and be externally verifiable through major stock or bond indexes. Beware self-serving, customized benchmarks proposed by advisors.
Ensure your asset classes add value. Comparing the performance of individual classes to benchmarks used for other classes can help identify cases in which a class is under-performing. If a small-cap manager cannot beat the S&P 500 Index over an extended period, then maybe the plan does not need small-caps in its portfolio.
Determine what service is expected. Small hospitals may find that they are served by salespeople or inexperienced junior staff who lack knowledge or credibility. Expectations need to be set when contracts are drafted.
Diversify, don’t “di-worsify.” Diversifying by investing in a dozen-plus asset classes can actually worsen outcomes. First, it turns a portfolio into an index, which guarantees that the portfolio will underperform the markets by at least the expenses of the underlying vehicles plus the provider fees. Second, many specialty asset classes carry significantly higher expenses. Third, over-diversification hurts performance by focusing on so many asset classes that many are likely to underperform in any given period. Investing in as few as five well-chosen asset classes spread over the investment “style box” should provide sufficient diversification.
Trust, but verify. Sponsors should ensure that performance data submitted in competitive procurements are audited and relevant. For example, if you are reviewing a manager with solid long-term results be sure to confirm that the investment team responsible for the performance is still in place.
Look at risk- and expense-adjusted returns. Two asset managers may have exactly the same results, but what risk did each of them take in getting there? Common measures of risk, such as standard deviation or beta, can help determine which manager is really the better performer. In addition, look at the impact of expenses: if an advisor uses mutual funds, the sponsor is paying not only retail expenses but also the advisor’s fee.
Don’t chase performance. The average manager underperforms benchmarks approximately 40 percent of the time, and even all-stars have slumps. If a manager with a solid long-term record is underperforming, then the sponsor should see whether anything has changed in terms of style or technique. If not, then it is best to give the manager a timetable for improvement while closely monitoring performance. Including a set time frame for improvement in the IPS allows sponsors to be prepared for such an occurrence.
Provide some flexibility. Define asset allocation parameters using ranges rather than specific figures to allow managers the flexibility to respond to fluctuating market conditions.
Don’t get distracted by the short term. IPS objectives help retirement plans stay on track in the face of volatility, market shifts and transitory poor performance. Progress should be measured in years and decades, not in days and quarters.
Rebalance regularly. Rebalance to reduce exposure to the plan’s best-performing asset classes and increase exposure to underperforming ones. Rebalancing smooths returns and ensures that the plan does not overemphasize a particular class or take on too much risk.