Ryan A. Bailey is the head of investments at Children’s Health System of Texas, where he oversees $1.5 billion in assets. As the hospital's inaugural investment officer, he was tasked with establishing and building its investment office from scratch. In this interview, Bailey discusses the three main areas of change that would foster a health care system of institutional quality; why he favors diversified strategies and other strategies that are uncorrelated to the market; and why hospitals are set to be more active in the alternative investment space.
Ryan A. Bailey was recently named on Trusted Insight's 2018 Top 30 Health Care System Chief Investment Officers. He graciously spoke with us on Jan. 16, 2018. The following interview has been edited and condensed.
Trusted Insight: You were named the head of investments of Children’s Health nearly four years ago. Tell us about your process of establishing and building that investment office?
Ryan Bailey: Like any new role, I had to start by figuring out where we stood and where the organization needed to go. The organization had an investment program, but there were opportunities to enhance its level of institutional quality. Many hospitals are somewhat new to the investment office format, thus I had to manage the transition from a consultant-led approach to one that was governed by a sophisticated investment committee and led by a team of investment professionals who collaborated with institutional quality service providers. The process focused on changes in three key areas:
"Hospitals have an additional layer of complexity in that we manage multiple pools of capital."
#1: Investment Committee and Governance
The process began with the recruitment of an investment committee with a diverse and sophisticated set of investment backgrounds. Once assembled, I was brought in to evaluate the portfolio and build an institutional quality investment office. We initiated a new custodian search, consolidated all the Hospital’s assets into one institutional-grade provider, as well as evaluated and hired a new consulting team that better fit the needs of the Investment Committee and team. In addition, I worked with legal to ensure the proper governance was in place so that decisions could be made efficiently.
#2: Portfolio Strategy and Construction
Hospitals have an additional layer of complexity in that we manage multiple pools of capital. Children’s Health had a long-term pool, a foundation, a pension, and operating cash portfolios, all of which had different investment policies but a similar asset allocation and manager roster, excluding the cash pool. We rethought this setup; each pool has a different objective which implied they should have bespoke portfolios tailored to fulfill their purposes.
In the pension, we assessed both assets and liabilities and established a glide path to de-risk the portfolio as funded status improved. Once set, my team could work with our organization to establish planning and funding strategies, which has helped us to manage our pension assets more effectively. A similar analytical process was applied to both the Foundation and Long Term Pool, where we constructed a new long-term asset allocation view. We now look at the world in four broad asset classes: global equity, global fixed income, real assets, and diversifying strategies (which should have a beta of 0.3 or less).
After the allocation framework was established, we could fine-tune portfolio construction by assigning liquidity constraints to each pool, among other changes.
#3: Manager Selection
Given manager selection had been in the hands of the former consultant, we needed to develop a process for evaluating managers. Typically, manager selection is based on the ‘Four Ps’: People, Process, Performance, and Philosophy; however, in my experience, only performance changes frequently, and by the time you're making a decision on performance, it's too late.
We still look at performance but also incorporate the manager’s opportunity set, edge, and role in the portfolio. Adding these three additional elements to our process helps manage expectations and often gives us advanced warning of potential performance changes.
When evaluating Managers: (1) The opportunity set is market landscape based. We are focused on dislocations, catalyst, and valuations. (2) A manager’s edge(s) tends to be informational. We assess if a manager gets better information or gets the same information and does more with it. (3) The role in the portfolio is institution and portfolio-specific. We evaluate if a prospective manager is a better fit compared to the current roster, how will the addition of this manager change the portfolio, and is this space where we want exposure to, etc.
Trusted Insight: In markets with high valuations, low yields and low expected returns, what part of the markets intrigue you right now?
Ryan Bailey: Right now, valuations have made traditional, public markets less interesting. I’ve been more focused on diversifying strategies, particularly in reinsurance and a handful of other strategies that are uncorrelated to markets. We’re also running cash on the upper end as this gives us the option to be opportunistic should a change in valuations create a better hunting ground.
"Exogenous factors like tax reform can affect growth disproportionately and create clear winners and losers, which should favor active management and long/short specifically."
We’ve also tinkered with our equity portfolio by favoring active management over passive (e.g., redemptions from passive S&P 500 to fund long/short equity), with the thought process that markets are both overvalued and policy-focused. Exogenous factors like tax reform can affect growth disproportionately and create clear winners and losers, which should favor active management and long/short specifically.
Trusted Insight: What trends have you identified that are impacting how you invest?
Ryan Bailey: We’ve more closely focused on macro trends, particularly with central bank policies. For example, rates were kept relatively low across the globe and supported by quantitative easing (QE). We’re now watching closely as the Fed, BoJ, ECB and other major banks show signs of major policy divergences and asking, “How will this affect the market?”
Additionally, weakness in the greenback has led to the question, “How will this play out in commodities?” It requires us to consider the tailwind impact on our international holdings. And there are anomalies in credit that just don't make sense; like a European “junk bond” yielding less than the U.S. 10-Year. What we haven’t seen is a lot of distress, and that's what we're waiting for. This goes back to our decision to hold cash and focus on diversifying strategies.
Trusted Insight: Hospital investment offices, as a sophisticated entity, are a relatively new entrant into the institutional investing universe. What role do you see them playing over the next decade?
Ryan Bailey: Hospitals are the new kids on the block right now, but we’re already well on our way to contributing to the institutional investor ecosystem. Over the next decade, I would expect to see hospitals be more active investors in the alternative investment universe. So much so, that I would expect health care to be broken out as a separate category from the endowment and foundation space.
I also think that hospitals level of sophistication will be demonstrated during the next liquidity crisis since they should be able to stay front-footed given their capital positions.
Trusted Insight: What distinguishes Children's Health from peer institutions?
Ryan Bailey: There are three elements that distinguish Children’s Health from its peers:
First and foremost, our organization’s mission which is to make life better for children. We take this mission seriously and understand our office plays a supporting role in the tremendous impact Children’s Health has on the well-being of the patients we serve.
Additionally, we have a very sophisticated Investment Committee that can underwrite any investment that comes to our direction.
Lastly, Children’s is relatively new to private investing. Our private's program started in 2014, and we are actively investing to reach our double-digit target.
Trusted Insight: What is the most important lesson that you have learned in your career?
Ryan Bailey: The most important lessons learned to date is not to let structure (eg. Partnership, or 40 act, etc.) dictate your exposure. Understand exactly what you own…be able to dissect your portfolio and recognize the risks you’re taking.
When making investment decisions, separate the four P’s and focus on the opportunity set of your managers. Monitor it closely and use it to inform your expectations for how your managers will weather a particular market environment. Seek to develop strong relationships with your managers, as it can help you assess frontline views on an opportunity set. Sharing honest insights will always serve you well when developing a sense of trust and partnership with your managers.
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