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    HEALTHCARE QUARTERLY: COST OF INFLATION

    2Q 2022  |  15 Minute Read

     

    Healthcare systems enjoyed strong average returns last year, but stickier-than-expected inflation remains a concern in 2022 as rising costs erode profit margins. In our latest Healthcare Quarterly, we take a closer look at last year’s performance and how inflation and macroeconomic uncertainty are driving demand among CIOs for real assets, private credit, infrastructure and renewables.

     

     

    Year-End Snapshot

     

    Investment Performance: Not-for-profit healthcare systems ended 2021 on a high note, posting an average 12-month return of 11.6% verses 9.4% in the 2020 calendar year.

     

    Leverage: The cash to debt ratio ended 2021 at 200%, up from 192% in the same period last year. At a component level, 20pp of the increase could be attributed to unrestricted investment performance and contributions, while balance sheet cash and debt contributed an estimated -12 percentage points and -1pp, respectively.

     

     

    Top 30 Healthcare Systems Investment Performance1

     

    Source: Goldman Sachs Asset Management and company filings. As of December 31, 2021 (latest available). Data as of indicated quarter end. Past performance does not guarantee future results, which may vary.

     

    Market Performance

     

    Source: Goldman Sachs Asset Management and Bloomberg. As of June 30, 2022. Past performance does not guarantee future results, which may vary.

     

    Top Healthcare Systems Aggregate Leverage3

     

    Source: Goldman Sachs Asset Management and company filings. As of September 30, 2021; latest available. Data as of indicated quarter end.

     

    Asset Allocation: Not-for-profit healthcare systems maintained their strategic discipline in 2021, only seeing slight asset allocation changes versus 2020. Notably, systems slightly reduced their equity and fixed income allocations, meanwhile increasing their alternatives allocations.

     

    Liquidity: Aggregate days cash on hand ended 2021 at 242 days, down from 249 days in the same period last year. At a component level, 24 days of the increase could be attributed to unrestricted investment performance and contributions, while balance sheet cash and non-cash operating expense contributed an estimated -11pp and -21pp, respectively.

     

     

    Top 30 Healthcare Systems Average Asset Allocation4

     

    Source: Goldman Sachs Asset Management and company filings. As of December 31, 2021 (latest available). Figures may not sum to 100 due to rounding.

     

    Top Healthcare Systems Aggregate Liquidity5

     

    Source: Goldman Sachs Asset Management and Bloomberg. As of June 30, 2022.

     

    Contribution to Days Cash on Hand5

     

    Source: Goldman Sachs Asset Management and company filings. As of June 30, 2022.

     

    Top of Mind

     

    Labor Shortages

    COVID-19-related hospitalizations have ticked up in recent months amid the rapid spread of the BA.5 Omicron subvariant. As a result, healthcare systems have struggled to meet the increased demand for nurses, offering competitive compensation packages and limiting certain services in an effort to attract new talent and reallocate existing nursing resources.

     

    The shortage of nurses is an issue impacting systems nationwide. Some examples include:

     

    • Mount Sinai (NY) is facing nursing shortages at historic highs, noting that there were 771 unfilled registered nurse and nurse practitioner positions across the network as of early July.6
    • Broward Health (FL) is offering sign-on bonuses of up to $20,000 as it looks to fill approximately 400 registered nurse (R.N.) vacancies. New hires are also eligible for a pension plan and public student loan forgiveness, among other benefits.7
    • Johnson Memorial Hospital (CT) temporarily halted inpatient and outpatient surgeries effective June 9 due to “staffing shortages and unexpected resignations within the surgical services department.”8
    • Martin General Hospital (NC) announced in July that it would temporarily suspended operations of its ICU, encouraging patients to visit regional hospitals instead. However, these hospitals are facing high vacancies as well, with WakeMed at a 27% vacancy rate, Duke at 9% vacancy, and UNC at 1300 openings.9

     

    As healthcare systems look to fill these labor gaps, demand for travel nurses has skyrocketed. Some travel nurses are now earning wages that are over 20% higher than pre-pandemic levels, and at one point were earning double the pre-pandemic average rate.6

     

     

    Inflationary Pressures

    Stickier-than-expected inflation remains a top concern for healthcare systems as rising costs have eroded profit margins this year. Medical expenses rose 4.5% year-over-year in June 2022, posting the largest increase in almost two years. As prices, reimbursement rates, employment contracts, and other costs are often set a few years in advance, healthcare systems may see a lag in price changes, making the industry outlook more uncertain.10

     

     

    Rising Medical Care Inflation

     

    Source: Bureau of Labor Statistics. As of July 19, 2022.

     

    Key sources of inflationary pressure include:

     

    • Labor: The impacts of labor shortages and increased turnover have trickled through to cost in the form of higher wages and fewer hours worked.
    • Supply chains: A majority of personal protective equipment (PPE) and raw materials for drugs are produced overseas. Due to ongoing global supply chain disruptions, healthcare systems can expect delays, longer lead times, and volatile pricing.11
    • Pent-up demand: Procedures that were postponed due to COVID-19-related hospitalizations in 2020 are now being rescheduled. Moreover, warmer months often see higher volumes of elective procedures and more emergency visits as people spend time outdoors.

     

     

    Market Perspectives

     

    Markets have experienced heightened volatility year-to-date on the back of elevated inflation, rising rates, and recession concerns, with the S&P 500 posting its worst first-half performance in over 50 years. Scott Konicki shares his views on how healthcare systems can navigate the current macro market environment.

     

    Scott Konicki

    Head of Midwest Institutional Client Business, Client Solutions & Capital Markets

    Scott Konicki

     

    Healthcare systems faced a challenging operational and market environment in the first half of 2022. What are some headwinds that systems are coming up against?

    While a multitude of factors have contributed to challenged performance this year, these challenges have largely stemmed from inflation. On the operational front, margins remain well below pre- pandemic levels, with several systems seeing negative margins year-to-date. While patient volumes have recently seen some improvement on the back of pent-up demand, expenses continue to be a drag on margins due to higher labor costs and ongoing supply chain disruptions. Several patients that delayed treatment now require greater care and specialized equipment that is more costly to procure.

     

    In capital markets, persistent inflation has led to an increasingly hawkish Fed that has been front-loading the hiking cycle. Both equity and fixed income markets have seen deeply negative returns on the back of fears that the Fed may not be able to deliver a soft landing. In private markets, impending write-downs may raise concerns for systems that are over-indexed to private equity.

     

     

    With inflation proving stickier than expected, what are some ways in which systems can incorporate inflation hedges in their portfolios?

    As noted, public markets have sold off in tandem year-to- date, while private markets have proved more resilient albeit on lagged marks. While repricing is underway, wide spread inflation concerns continue to drive demand for real assets and private credit strategies. In general, assets that are short duration and/or allow for contract adjustments exhibit attractive characteristics in the current regime of higher-than-normal macro uncertainty. Depending on investor objectives, real estate (equity and credit), infrastructure, and renewable markets are just a few areas where investors are spending time to determine how they want to be positioned in context of an expected lower return environment going forward.

     

     

    How are healthcare CIOs thinking about renewable investments, and what are some interesting investment opportunities in the space?

    Whether for differentiated drivers of return or alignment of investment capital with sustainability goals, we believe the energy (battery) storage market presents a unique opportunity set for healthcare systems and other similarly situated institutional investors. The attention on grid instability and intermittency in recent years has been significant. The combination of declining costs and increased capacity of batteries presents an interesting demand/supply scenario for long-term investors to consider. While the battery storage market is small compared to other forms of private investment, the growth of the market will provide an opportunity for institutional investors to broaden their portfolio toolkit in real assets. As an example, in our 2021 healthcare investment diagnostic, 44% of respondents indicated they were considering investing in renewables in the next two years even though 71% did not have a specific climate or carbon emission reduction target. We believe this speaks to, in part, the demand for the unique sources of return that these assets present.

     

     

     

    Summary of Tactical Asset Class Views

     

    Source: Investment Strategy Group. Asset class views as of July 11, 2022. The Investment Strategy Group (“ISG”) is part of the Consumer and Wealth Management Division of Goldman Sachs and is not a part of Goldman Sachs Global Investment Research or Goldman Sachs Asset Management. Information and opinions expressed by individuals other than Goldman Sachs employees do not necessarily reflect the view of Goldman Sachs. Goldman Sachs does not provide accounting, tax or legal advice to its clients. Please see appendix for additional details on the above viewpoints. Views expressed are for informational purposes only and do not constitute a recommendation by Goldman Sachs Asset Management to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.

     
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    Healthcare Quarterly: The Cost of Inflation

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