The Value of an Enterprise Approach to Investment Management

Given the ever-changing crosscurrents of market and economic forces, institutional investors of all types would be wise to consider an enterprise approach to managing their investment assets. From liquidity-driven and income-focused portfolios to liability-centric insurance pools, a holistic investment management framework has the potential to benefit any institutional investor.

What is an “enterprise approach” and how is it different from a “return-only” strategy?

Simply put, an enterprise approach to investment management considers the impact of investment risk within an organization’s broader financial health, versus an approach that addresses the expected return of a portfolio in isolation. To illustrate this concept, consider a healthcare provider that monitors days cash on hand (Figure 1) to inform its investment strategy. In a return-driven approach, the provider might only consider the numerator (unrestricted cash and investments) where investment market returns have a clear effect. In contrast, astute stewards of capital typically find it advantageous to consider the interplay between the numerator and denominator (cash-based operating expenses) as many providers’ days cash on hand have come under considerable stress in recent years given financial market volatility and rising supply and labor costs.

Figure 1.

In this example, operating expenses are influenced by many factors, such as the cost of drugs and other supplies and, of course, labor markets. Days cash on hand can fall due to a decline in liquidity (the ability to convert resources to cash, the numerator), a rise in costs (the denominator), or both. A hospital system solely focused on investment return might be tempted to make material allocations to illiquid alternative investment strategies — an asset class known to offer high return potential in exchange for lower liquidity.

But what happens if investment markets pull back amid a challenging operating environment? A possible outcome is days cash on hand shrinks on both sides of the fraction — the numerator falls on negative returns and the denominator rises due to increasing costs (Figure 2).

This “double whammy” scenario could prove especially challenging for a provider that has invested too heavily in illiquid alternatives, as these strategies often come with higher volatility. A potential negative outcome is greater investment losses pairing with rising operating costs resulting in a liquidity debt covenant violation, as seen by the “With illiquid—Negative Returns and Increasing Costs” line in Figure 2.

However, a provider subscribing to an enterprise approach might make a more measured allocation to illiquid alternatives, keeping in mind the need to maintain liquidity in a challenging operating environment. This provider may still see its days cash on hand decline, but not so sharply as to lead to a covenant violation, as represented by the “Liquids Only – Negative Returns and Increasing Costs” line.

Figure 2. Days Cash on Hand

Investment strategies with illiquid alternatives might offer greater return potential, but also pose more downside risk—a key consideration to shoring up liquidity when operating costs rise.

Figure provided for illustration only. Not based on actual data.

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What does the successful implementation of an enterprise approach look like?

Several documents are necessary to analyze an organization’s current investment strategy, including the investment policy statement, spending policy and current investment statements. These documents provide detail about how the current asset allocation may differ from investment policy targets and the opportunities that may arise from integrating financial statements with investment goals. While the core financial statements — the balance sheet, income statement and cash flow statement — can tell the story of how investment risk has influenced an institution’s overall financial health historically, a budget, multi-year projections and other operating assumptions can help develop and implement a longer-term strategic vision.

Consider a university that forecasts gifts or other contributions into its endowment and assumes a portion of its endowment spend will go to the maintenance and construction of campus facilities. A holistic approach can help inform how investment performance can aid or hinder projects that influence other important revenue streams, such as tuition and fees.

A holistic approach to investment management for colleges and universities would consider many factors: endowment gifts, construction and maintenance projects, and enrollment goals, to name a few.

For example, what if the draw from the endowment was insufficient to support the completion of a critical capital project on a timely basis? Would the university be able to achieve its enrollment goals, and what would be the ensuing impact on tuition revenue? Or, if borrowing from the endowment is possible, what are the longer-term costs from a strategic, maintenance and engagement perspective of lower endowment net assets in the near term? A return-only approach might advise on how to maximize net assets, while an enterprise approach has the potential to make goal attainment the focus by examining how each factor influences a range of potential outcomes.

For an organization to measure its investment success, a customized benchmark that reflects long-term asset allocation targets is valuable in just about any investment policy statement. However, we caution against tying the definition of success entirely to performance relative to a benchmark, as it does not always capture the full picture.

Consider a property and casualty insurer that increased the duration — a measure of interest rate sensitivity — of its fixed income portfolio during the low-rate environment following the 2008 financial crisis to improve returns. While many insurers may have felt compelled to extend duration to boost investment yield and keep pace with a benchmark, the market value of this fixed income portfolio would have fallen precipitously as the Federal Reserve began aggressively raising interest rates in the spring of 2022, as illustrated in Figure 3.

Figure 3. Market Yield on U.S. Treasury Securities at 10- Year Constant Maturity, Quoted on an Investment Basis

Longer-duration bond portfolios would have lost more value relative to shorter-duration ones during the Fed’s 2022 – 2023 rate hiking cycle, all else being equal.

As of: 12/31/2023. Source: Federal Reserve Economic Data

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A “fire sale” type scenario became a reality for many that year as inflation and catastrophe-driven losses wreaked havoc on industry financials, creating a downward spiral. A holistic approach to investment management could consider these elements in an integrated model: the value of investment income, the possibility of elevated losses, the benefit of matching asset duration to that of liabilities and — perhaps most importantly — how investment performance and operating activity influence policyholder surplus in tandem.

By understanding how investment decisions play a role in commonly followed metrics, such as the ratio of premiums written to policyholder surplus, operational risk becomes a key component of the investment strategy. In our view, this is a win for organizations that place a premium on corporate governance.

Reaping the rewards

We consider an enterprise approach to investment management timeless and a staple on any institutional investor’s task list. Organizations that implement investment programs in the context of their broader financial measures of success have the potential to benefit from sound investment discipline many years into the future.

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Figure 2: Days Cash On Hand(view image)

Year	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Liquids Only - Negative Returns and Increasing Costs	250.00	235.58	221.99	209.18	197.11	185.74
With illiquid - Negative Returns and Increasing Costs	250.00	225.96	204.23	184.60	166.85	150.80
Liquidity Covenant	175	175	175	175	175	175