Partners Healthcare

Which real asset would provide the better risk-return trade off?

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Copy of case report that answers the questions listed below. Those questions are not meant to be exhaustive. So feel free to discuss other things you deem important. You are encouraged to collect facts and/or data
to support your arguments.
1. As a healthcare organization, why does the Partners care so much about its financial
investments? How does the Partners manage its investments? Are there any chal-
lenges when making investment decisions? What are the proposed changes and the
motivations behind such changes?
2. Suppose different hospitals within the Partners choose different mixes of the \risk-
free” STP and the baseline LTP, whose future expected returns and risks are shown in
Exhibit 3. On a risk-return graph, plot the returns and risks of the various potential
portfolios in Exhibit 3. What shape does a line drawn through these portfolios take?
In contrast, what would the risk-return opportunities available to the hospitals be if
they could invest only in the STP and US Equities?
3. Suppose the hospitals within the Partners can invest in the STP and only one
of the
two real assets (and nothing in the baseline LTP). Which real asset would provide the
better risk-return trade off? Explain your answer.

Which real asset would provide the better risk-return trade off?

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4. On a risk-return graph, plot a curve of the optimal portfolio combinations in the
baseline 3-asset case detailed in Exhibit 5a: US Equities, Foreign Equities, and Bonds.
(Hint: This curve should look just like the one in Exhibit 5b.) Then, on the same
graph, plot a curve of the optimal portfolio combinations in the 4-asset case in Exhibit
6: US Equities, Foreign Equities, Bonds, and REITs. Do the same for the 4-asset
case in Exhibit 7: US Equities, Foreign Equities, Bonds, and Commodities. Does the
addition of each real asset improve the risk-return opportunities? If so, how? Which
real asset brings more improvements? Can you reconcile your answer here with the
one in part 3?
5. Plot a curve of the optimal portfolio combinations for the 5-asset case in Exhibit
7. Compared with the curves in part 4, do you get better risk-return opportunities
by adding both real assets to the LTP? Should dierent hospitals choose dierent
combinations of the ve assets (i.e., dierent LTP)? Why or why not? On the curve,
which combination of the ve assets provides the best risk-return tradeo? (Hint:
Graphically, nd the point with the highest Sharpe ratio on the 5-asset curve. No need
to do any formal calculations.)

Which real asset would provide the better risk-return trade off?

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6. Suppose one member hospital wishes to invest in the STP and the LTP such that the
total expected return on its portfolio is 8%. Graphically, illustrate the improvement in
risk by switching from the baseline LTP to the new optimal LTP in part 5. Similarly,
illustrate the improvement in return for a member hospital that targets a portfolio
standard deviation of 12%.
reproduced, stored in a retrieval system, us
ed in a spreadsheet, or transmitted in any form or by any means—electronic, mechani
cal,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
JOSHUA COVAL
Partners Healthcare
In May 2005, Michael Manning, the deputy trea
surer of Partners Healthcare System, was
formulating a recommendation to the Partners Inve
stment Committee. He had been asked to analyze
the role that different “real assets” could play
in Partners’ $2.4 billion long-term pool (LTP) of
financial assets. He was then expected, on the basis of that analysis, to recommend both a size and a
composition for the real-asset port
folio segment within that LTP.
Background

Which real asset would provide the better risk-return trade off?

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Partners Healthcare System was the largest he alth-care network in New England, providing a
range of primary, secondary, and tertiary health-care services to millions of patients from throughout
eastern Massachusetts. The Massachusetts General Hospital and the Brigham & Women’s Hospital,
two world-famous acute-care hospitals in Boston, had joined together in 1994 to found the Partners
network. Both Mass. General and Brigham not only provided acute clinical care but were also
research and teaching hospitals affiliated with the Harvard Medical School. Over the next few years,
four suburban hospitals had also joined the network, as had dozens of physician organizations
(practices with multiple numbers of doctors) across eastern Massachusetts. A variety of important
staff functions, including treasury functions like asset management, had been
centralized at Partners headquarters in downtown Boston, but all the clinical care and research took place in the
decentralized network of hospitals and physician offices (see

Exhibit 1). Partners’ Treasury

Which real asset would provide the better risk-return trade off?

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Department, headed by Manning, reported up through a senior vice president of Treasury to the chief executive officer and the board. Importantly, there was also an investment committee consisting of well-known and respected investment professionals who determined the investment policy for Partners’ pools of investments, several of whom also served as directors and trustees of Partners and its affiliated hospitals.

While Partners and each of its hospitals were nonprofits, they nonetheless had significant financial
assets that played a critical role in their overall financial strategy. Like universities, the hospitals
sought charitable contributions, often from grateful patients, and several of Partners’ hospitals had
accumulated significant endowments that helped to fund some of their clinical, research, and
teaching programs. To varying degrees, the hospitals also had accumulated other general long-term
funds that served as both a financial buffer against the possibility of operating losses and as a general
long-term store of value. Since its founding, Partners’ operating results had fluctuated, but operating
margins had been quite modest on average relative to the 3% margin Partners management believed
they needed to maintain a healthy rate of capital in vestment in new clinical and research facilities (see
For the exclusive use of H. Gong, 2016.

This document is authorized for use only by Hongfei Gong in FIN7041-16SS (Investments) taught by Chen Xue, University of Cincinnati from January 2016 to April 2016.
206-005

Partners Healthcare 2 Exhibit 2).

Which real asset would provide the better risk-return trade off?

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Since its founding, the investment returns from Partners’ LTP had played a crucial role in
maintaining the financial health of the organization (seeExhibit 2).

In order to accommodate the differing needs of the various hospitals in the network, Partners
Treasury had established several centrally managed pools in which the networks’ various hospitals
and physician organizations could invest their financial resources. For purposes of this portfolio
analysis, Manning focused on two of these pools, the short-term pool (STP) and the LTP.

The STP was managed internally by several fixed-income managers on Manning’s staff, who invested it in
very high-quality, short-term fixed-income instruments with an average maturity ranging from one
to two years. Partners thought of this pool as a very safe pool that could be used by the various
hospitals as the risk-free part of their holdings.

In the spring of 2005, the average yield on this portfolio was 3.2%. The LTP, in contrast, held risky assets, primarily different forms of equity. Over 30 different external asset management firms that were selected and monitored by the Partners Investment Committee and investment staff managed those equities. There was also a smaller fixed-income segment in the LTP that was invested primarily in high-quality long-term bonds. The various hospitals in the Partners network each had very different characteristics including their geographic target markets, their operating margins, their vulnerability to underpayment by Medicaid and/or other various third-party payers, and especially
the size of their endowment assets and other financial assets relative to their operating budgets.

Which real asset would provide the better risk-return trade off?

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Manning and his Treasury staff worked with the CFOs of the network’s hospitals to determine appropriate percentages of their financial assets to invest in the various pools. Not surprisingly, different hospitals chose different allocations to the long-term and short-term pools as a function of their own unique financial characteristics and also their risk tolerance.

Real Assets

Over the last several years, the Partners Invest ment Committee had introduced a new category of assets called real assets into the LTP. Concerned about the future risks and returns from traditional financial assets such as stocks and bonds, the Investment Committee had searched for untraditional asset classes that might help diversify the risks of the LTP. They were particularly interested in asset classes that might perform well in a rapidly expanding global economy and/or a resurgence of inflation.

As two initial steps in this direction, they had invested a percent of the LTP in a diversified portfolio of publicly traded real estate investment trusts (REITs) and another percent in a diversified portfolio of commodity futures that approximat ely tracked the Goldman Sachs Commodity Index (GSCI). As it turned out, both of these newly a
dded subportfolios had done extremely well in 2004, making the real-asset program a great initial success. “Better to be lucky than smart,” thought Manning, for he knew that the more interesting questions concerned the long-run ways in which these two types of real assets might affect the risks and returns of the LTP, particularly if their allocations in the LTP were to be increased subs tantially. The Investment Committee was considering a major expansion of the real-asset segment of the LTP, but they wanted Manning to analyze the potential implications of this decision very carefully before proceeding.
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Which real asset would provide the better risk-return trade off?

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In addition, there was a money market pool for transact ional balances, an ERISA pool for pension assets, and an
intermediate-term pool for funds with a three- to five-year time horizon. These other pools will be ignored for the sake of simplicity in this case. For the exclusive use of H. Gong, 2016. This document is authorized for use only by Hongfei Gong in FIN7041-16SS (Investments) taught by Chen Xue, University of Cincinnati from January 2016 to April 2016

By admin in Essays on November 1, 2016