Jan Furrer: In general, the macroeconomic environment, higher all-in asset yields, the shift from public to private securities, impact investing, and technological advancements are the current key trends that influence our thinking on how we manage assets versus liabilities.
For background, Zurich’s mission is to achieve superior risk-adjusted returns relative to liabilities, and we implement primarily with best-in-class external asset managers. However, our scale in alternative assets enables us to internally manage our hedge funds, private equity, and real estate.
"We also have been able to invest across private equity sectors and vintages consistently at a time when many institutional investors have had to pause."
Our implementation approach, and the market and regulatory environment in North America, gives us the flexibility to benefit from these trends. For example, in the current ‘higher-for-longer’ interest rate environment, we have rebalanced to specific strategies to gain extra return over liabilities. This has enhanced our reinvestment opportunities, leading to higher book yields and our overall investment income.
We also have been able to invest across private equity sectors and vintages consistently at a time when many institutional investors have had to pause. As another example, we are a responsible investor, so we support Zurich’s objectives to be aligned with societal and environmental impacts without sacrificing investment performance.
Our team’s structure has also enabled us to develop tools that improve our investment decisions.
Jan: The US macroeconomic environment, particularly post-Federal Reserve decisions, highlights the importance of Asset-Liability Management (ALM) and Strategic Asset Allocation (SAA) in the decision-making process.
Given the slowdown in growth, we still expect the Fed to cut rates later this year, which is an important factor for further stock market gains, while bond yields start to look more attractive at these levels. Both equities and credit would suffer if the Fed took a more hawkish stance and interest rates keep rising.
Our ALM is crucial as we manage interest rate risk, which has been highlighted by recent bank failures driven by the interest rate hiking cycle. To mitigate these risks, we maintain a net monetary duration target for our assets versus liabilities ensuring our economic solvency. This rigorous ALM strategy helps us to manage and withstand market shocks, for example during Covid or the fastest Fed rate hike cycle from March 2022 to July 2023.
In addition, our SAA focuses on optimising rewarded risks particularly in equities and credit markets. Consistent with empirical studies, we have found that ~80% of our excess return over liabilities is explained by ALM and SAA, with the remainder coming from Tactical Asset Allocation (TAA) and security selection, the so-called alpha contribution. For us today, given how tight credit spreads are, our current assessment is that there is more down- than upside potential in US Corporate Bonds, and that certain private credit markets continue to provide strong risk-adjusted investment opportunities.
Jan: Broader macroeconomic factors and political decisions, such as those from the Biden administration concerning taxes, can impact our investment strategies, particularly our SAA. While our exposure to tax decisions is indirect, changes in tax policy can influence markets and affect our holdings in tax-sensitive instruments like corporate or municipal bonds.
Concerns about the US debt levels have caused us to assess the potential for a US credit rating downgrade and increased interest rate volatility. While we have not made any corresponding adjustments, and we continue to rely heavily on US government securities, we regularly assess such factors.
Jan: Given that our investment strategy is based on a rigorous ALM and SAA approach, we are well positioned to navigate local regulatory landscapes. Our asset class decisions are both regulatory-informed and capital-conscious, so we address market risk consumption accordingly.
"We have a constructive relationship with our regulator."
The National Association of Insurance Commissioners (NAIC) [way of operating] differs from Solvency II or the Swiss Solvency Test. NAIC tends to be capital friendlier towards less liquid assets such as private credit. For example, we require our fixed income instruments to carry an NAIC Securities Valuation Office (SVO) approved credit rating so that even private credit may benefit from attractive capital charges. As a result, our US balance sheets are an important carrier of illiquid assets as part of the global Zurich Group SAA.
We have a constructive relationship with our regulator. For instance, if the NAIC publishes a revised investment regulatory framework proposal, any asset owner or allocator may provide feedback.
Jan: We are constantly reviewing new asset classes and themes that align with our investment objectives, particularly those that support risk-adjusted returns versus liabilities, bring a level of diversification, and incorporate ESG factors.
"Infrastructure Equity is also an asset class that we are considering given its diversification benefits and attractive return versus risk profile."
We are currently reviewing the use of ETFs as an efficient asset allocation and market risk management tool. For example, this may mean that we can move quickly when a market opportunity arises or an ALM position needs to be adjusted.
Infrastructure Equity is also an asset class that we are considering given its diversification benefits and attractive return versus risk profile.
Additionally, we have recently committed funds through our internal private equity manager to one of the leading venture capital firms, which specialises in AI and emerging technologies.
Jan: We have high-quality commercial mortgage-backed securities (CMBS) debt and direct commercial Real Estate equity exposure. It’s diversified across various sectors and regions in the US. For example, our CMBS exposure is mainly AA-rated and higher.
Our direct commercial real estate equity exposure is revalued annually, with ongoing management by our internal real estate asset manager to assess valuations and market opportunities carefully. Overall, the US Real Estate risk is very well maintained and closely monitored.
Jan: For us, impact investing is important, as it allows us to target specific social or environmental impacts that are measurable and profitable, ensuring returns are in line with their risks.
For instance, our SAA includes a green bond portfolio supporting various green projects and other impact investments such as social and sustainability bonds. Also, we are working with managers on transition finance projects through infrastructure debt, for example.
"When we do ‘good', we have a positive impact on society and the communities where we live and work."
Additionally, we integrate ESG language in our agreements with the external asset managers and maintain an ESG restricted list to limit exposure to industries such as oil, coal, and gas. We regularly update our list of restricted securities to avoid increasing exposure.
These efforts reflect our objective of doing both ‘well’ and 'good’. When we do ‘well’, we generate returns for our customers and shareholders. When we do ‘good', we have a positive impact on society and the communities where we live and work.
