We at Solaris Advisors have guided the investment portfolios of many life plan communities and have long been proponents of an approach that balances portfolio risk with operational or enterprise risk. We work with databases that have financial statements of life planning communities to compare the operational statistics of LPC’s to their various asset allocation schemes.
We create peer groups that relate asset allocation to statistics that rating agencies and lenders look at so as to compare apples to apples. One easy way to create a peer group is to look at is a bond rating category. From there we can segment further by community size and scope (single site vs. multi-site for e.g.), contract type or geographic area, among others.
We recently looked at a peer group that shared a BBB category rating from a recognized rating agency. After rationalizing the data, we found solid consistency among group members on a range of operational statistics, but of course there are always outliers. Debt service coverage averaged 2 times but covered a range of 1.4 to 3 times. Maximum annual debt service as a percentage of total revenue averaged 12, but there were some LPC’s in single digits and several in the mid-to-high teens. One adaptation we made on the debt service coverage ratios was to look at the percentage decline in net turnover that would result in problems meeting a hypothetical 1.2 x covenant. The average for our sample was nearly 70%, but some communities were as low as 20-30%, which struck us as a thin cushion for an investment grade bond.
We were mildly surprised to see that the average allocation exposure to equities was around 50%. Perhaps this was a result of recent “return-chasing” and/or market run-up that has elevated risk in many individual portfolios as well. Among the peer group, allocation to equities ranged from a low of 30% to a high of 75%. But it was particularly interesting to learn how the equity allocations matched up with the operating statistics. One would think that the strongest enterprises would be able to “afford” more risk and have the most aggressive allocations to equities. But in fact, we found that some of the highest equity allocations were associated with LPC’s that seemed more dependent on net entrance fees. On the other hand, some communities with lower allocations to equity were among the strongest financially.
Looking at fixed income allocations, we saw a very wide range (from 4% to 65%) around an average allocation of 43%. Fixed income is the big investment conundrum today, as interest rates are low and the prospect of capital gains is diminished. This begins to explain the rationale for why there has been this creeping increase in equity allocations. Yet it appears that equities, as an inherently more volatile asset class, are capable of doing more damage to portfolios than bonds. In other words, replacing some fixed income with equities at this time may be playing with fire.
Which brings us to alternative investments, i.e. those strategies that are designed either for absolute returns or better risk-adjusted returns. The average allocation metric for the alternative category was not as meaningful as the other statistics in the peer group study due to the fact that more than half the study subjects had no exposure to them. This may be an educational issue or it may be that recent historical returns of these investments have not stacked up against the stock indices (What has?). In an environment where the traditional portfolio ballast, fixed income, has a questionable risk/return trade-off and equities have been driven up in valuation in part by the comparison to fixed income prospects, one would think that alternative investments, an asset class that is more focused on risk management, would be more in demand.
Asset allocation, of course, is part math and part forward-thinking judgement (hopefully). While our data analysis does not reveal the judgmental aspects of the portfolios in the sample, we suspect that additional rigor regarding the balancing of enterprise risks and opportunities with market risks and opportunities would be of real value to life planning communities.
We invite you to contact us if you would like to see a complimentary customized peer group study for your community.