Partner’s Healthcare Write-up

Partner’s Healthcare Write-up

Partners Healthcare currently holds a long-term pool (LTP) of financial assets and contemplates on making additions of more real assets, commodities as well as Real Estate Investment Trusts (REITs). This suggestion is to compared and verified to determine whether additions to the already existing assets will increase the hospital’s return. It is ascertained that the risk-free rate is 3.2%.

Since the Short Term Pool bears an almost fixed rate of return, the variation from the Long Term Pool is going to determine the risk and return of the individual portfolio.  From the analysis, a suggestion is raised that the company should include LTP to all 5 assets in the portfolio. To determine the optimal portfolio allocation, Partners Healthcare is expected to find a portfolio that is structured with the lowest level of risk given a particular return rate. To arrive at this optimal allocation, the Mean-variance and Markowitz models will be used to arrive at the efficient frontier. In this regard, the asset allocation should be: the US Equity should be allocated 24.32%, the Foreign Equity should be allocated 30.87%, Bonds should be allocated 10.83%, and REITs should be allocated 9.91% while the balance of 24.07% should be allocated to Commodities.

Through this allocation, a “one fits all” d in the solution has been arrived at as represented in the portfolio. Risk preferences differ among investors and although in this case risk aversion will differ, the optimal allocation mix for the risky long-term pool will not differ. However, the tangency in the portfolio changes, as indicated in the efficient frontier, will change as per the level of risk aversion.

Recommending a portfolio with all the 5 assets is backed by some considerations. Among those considerations is the Sharpe ratio. With the portfolio including all 5 assets, the Sharpe ratio is highest as compared to the rest. Given the risk, a high Sharpe ratio indicates that the portfolio has a higher risk premium. Besides, considering raising the number of assets in the portfolio reduces the transactional cost while providing lower setup costs. From the analysis, the negative correlation of commodities with three other assets helps in increasing the portfolio diversification.

Analysis of the portfolio addition of assets supports the need to make the investment in the optimal portfolio of all the 5 assets. Partners Healthcare has an investment mix that includes 55% as US Equity, 30% as foreign Equity and 15% as bonds. This is before making the additions of the real assets. By using the expected return, the standard deviation and coefficient of correlation, the optimal portfolio of the three assets is seen to comprise of 40.66% of US Equity. Foreign Equity comprises 47%, while the long term bonds consist of 12.33%, as indicated in Exhibit 1. Moving further along the efficient frontier, the weighting on both the US equity and foreign Equity will increase as that of bonds decrease.

Correlation between long term bonds foreign Equity is (0.06) while that of bonds and US equity is (0.25). These are lower compared to the correlation between US equity and foreign Equity, which is equal to (0.62). Besides, as the portfolio risk increases, the weights of risky assets, which are the US and foreign Equity, should have a similar trend in increase. These two assets are riskier, but their high rate of return compensates this.

When REITs are added to the three asset portfolio, as we move along the efficient frontier, the weighting of bonds and REITs decreases while the weights of US  and foreign equity increases.  This is explained by the fact that when risk increases, the asset allocation to bonds and REITs, which have relatively, lower risk, decreases. On the other hand, higher-risk assets such as US equity and foreign Equity will have lower allocation. As a consequence, the portfolios expected return and risk decreases owing to the introduction of REITs, which reduce risk and the expected rate of return as well.

When commodities are added and moving along the efficient frontier,  the weights of US equity, foreign Equity, as well as commodities, increase with the weights of bonds significantly decrease. Further, the overall portfolio risk and return decrease as commodities and bonds have a negative coefficient of correlation. Similarly, there is a negative correlation between Commodities and US equity. Adding both REITs and Commodities to the three-asset portfolio has the effect of decreasing the portfolio risk. Adding REITs and Commodities reduces the portfolio risk by 0.6% and 2.16% respectively while adding both of them together decreases the portfolio risk by 2.52%.  The analysis indicates that as Partners Healthcare increases the number of assets in its investment portfolio, the weighting in each of the assets decreases.

Overall, each hospital can make allocations between STP and LTP. They can always create the most efficient portfolio with the allocation of a combination of the two.  Choosing a rate of 10%, then a combination of STP and O3-asset and STP and O5-asset with appropriate weighting would arrive at an efficient portfolio. Similarly, allocating money using STP and O3-asset and STP and O5-asset would lead to similar results. Generally, Partners Healthcare can control the risk of long term pool through the expansion of its real assets base. Therefore, combinations of risk-free STP and improved LTP will result in the construction of the most optimized portfolio at any risk level.