Managing and optimising your Refundable Accommodation Deposit (RAD) portfolio, the 3rd lever in facility funding.
One of the key issues aged care providers need to address are the growing funding challenges. There are 3 levers in which to manage funding (i) mandated government support where you have no control, (ii) consumer pricing with often limited control, and (iii) the management and optimisation of RAD portfolios. Effective Aged Care providers manage the latter to provide additional revenue to fund adequate staffing levels and capital improvements, which can then generate more consumer pricing control.
Historically, RAD portfolio management has been targeted at specific asset mixes to either (i) ‘over-reach’ on the liquidity requirements (i.e., overweight low interest-bearing cash at call and short dated term deposits. The missed revenue opportunity was further exacerbated recently when historical yields were low) or (ii) ‘over-reach’ on the targeted returns required through taking excessive asset risk (i.e., overweight equities or illiquid property).
Noting this backdrop, RAD portfolio management has subsequently not considered the key advantages of investment grade credit (including diversification, low correlation to equity and other risk assets, and strong company fundamentals) as well as the ability for bonds to offer staggered, liquidity maturity profiles. For example, investment grade credit can have a 1-,2-, or 3-year staggered, maturity profiles which can be heavily concentrated in the 1-year bucket (if necessary) to meet an aged care providers liquidity management strategy (LMS) or any upcoming capital requirements or improvements.
A flexible investment strategy is needed as other costs (mainly those linked to inflation and consumer pricing) and lack of government funding within the aged care sector have risen exponentially. Thus, a better allocation will have a multiplying effect on the bottom line.
The Australian fixed income landscape is now very different to 18 months ago with investment grade credit now offering very attractive potential returns. The yield on the corporate Bloomberg AusBond Credit Index is now 5.5% as at the end of August 2023, with the index yielding close to 1% just 18 months ago. In financials, Tier 2 subordinated Australian bank bonds (such as NAB, CBA, ANZ etc) have a yield in the mid 6%, with longer-end Tier 2 bonds touching 7%.
Although inflation will continue to be an issue for the next 6-12 months and the global economic recovery is uneven, investment grade credit should resume its status as a good portfolio diversifier with a low correlation to equity and other risk assets. Balance sheets look very healthy as companies have accumulated cash over the past couple of years. Finally, with indications that central banks are nearing the end of their current interest rate hiking cycle, duration exposure is of particular importance today. Effectively, locking in longer term interest whilst you can.
Most outperforming investment portfolios should include an allocation towards cash and term deposits and investment grade credit. The cash and bonds allocation can be structured via a cash management solution in conjunction with a discretionary investment grade credit account.
Case Study
IAM currently manages a $250 million portfolio for an aged care provider who has chosen to fill their defensive allocation, predominantly in investment grade credit over cash and term deposits. In accordance with the Aged Care Act 1997 (Cth), investment grade credit offers protection of capital and meets cash flow requirements, including repaying RADs, but offers better returns than cash and term deposits.
For more insights and trade ideas, reach out to your IAM Relationship Manager.
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