Medical Scheme Investment Strategies: is cash enough?

Medical scheme custodians face a challenging hurdle: cash provides low-risk stable returns but doesn’t keep up with medical inflation …. how can medical schemes maintain their required capital reserves / liquidity limits without exposing them to short-term capital fluctuations? Natasha Narsingh, Senior Portfolio Manager at Sanlam Investments, explains.

As a medical scheme, your biggest challenges with maintaining your 25% solvency level are:

• ensuring capital preservation
• maintaining appropriate levels of liquidity (access to cash) to cover the scheme’s short-term liabilities
• mitigating annual member contribution increases
• ability to achieve investment returns exceeding claims inflation
• managing the risk of capital losses while still achieving the highest possible rate of return
• minimising volatility of returns.

For medical schemes to meet and maintain their capital reserve targets, they most certainly need a higher allocation to inflation-beating asset classes (or ‘growth assets’) to be able to outperform medical inflation over the long term. Given future inflation expectations, cash just isn’t going to cut it.

Why cash isn’t enough
Let’s assume your scheme’s internal benchmark for meeting your capital reserve requirements is inflation + 3%. If we then look at the performance of cash above inflation, you’re going to be disappointed.

Source: Sanlam Investments, November 2015

From the graph, you can see at a glance that cash on average struggles to keep up with inflation (CPI) compared to other asset classes over the long term. Considering that medical inflation generally tends to be   higher than general consumer price inflation (CPI), cash returns tend to be below medical inflation. Medical schemes now face a double-edged sword: the inflation risk of sitting in cash only on the one hand (which will erode your capital) or exposure to potential capital losses in the short term if you’re invested in potentially higher return but riskier, more volatile asset classes.

A viable alternative to cash-only investments – worthy of consideration by medical schemes – would be an absolute return investment strategy. This presents a highly efficient way to target inflation-beating returns over time, while at the same time protecting against capital losses through efficient risk management strategies.

Know your asset manager!

There is little doubt that an absolute return product may be the most effective solution to the problem. But choosing the right absolute return manager is essential. Choose a manager who will give you greater exposure to growth assets while still providing you with consistency of returns and the capital protection needed during volatile market conditions.

We do it differently
At Sanlam Investments, our strong, considered focus on risk management is well suited  to better assist medical schemes manage the risks they  face, while being able to achieve consistently higher risk-adjusted overall investment returns.

Very simply, we enable you to achieve higher returns, but not at the expense of higher risk. Portfolio risk and volatility of returns is reduced via the explicit use of carefully considered protection structures that we implement in our funds, acting as an insurance or a buffer against market falls. So when markets fall, your capital doesn’t fall by as much. By limiting the drawdowns or downside risk within your portfolio, capital is effectively preserved over time, while at the same time we e manage our funds with the aim of achieving, the highest possible rate of return per unit of risk taken, and actively smooth out returns.

Make your surplus work for you
We structure absolute return strategies (Regulation 30 compliant) for our medical fund clients to explicitly target real (inflation-beating) returns over 3 to 5 years, while aiming to preserve capital over any rolling one year. Having a surplus greater than 25% will ensure your scheme can sustainably provide members with improved benefits at the most affordable contribution rate.

Disclaimer
Sanlam Investment Management (“SIM”) is an authorised Financial Services Provider. This publication is intended for information purposes only and the information in it does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act. Although all reasonable steps have been taken to ensure the information in this document is accurate, SIM does not accept any responsibility for any claim, damages, loss or expense, however it arises, out of or in connection with the information in this document. Please note that past performances are not necessarily an accurate determination of future performances and the performance of the fund depends on the underlying assets and variable market factors. International investments or investments in foreign securities could be accompanied by additional risks, such as potential constraints on liquidity and the repatriation of funds, macroeconomic risk, political risk, foreign exchange risk, tax risk and settlement risk, as well as potential limitations on the availability of market information. Independent professional financial advice should always be sought before making an investment decision.