Eric Kirsch is the executive vice president and global chief investment officer at Aflac, where he oversees the $100 billion-plus investment portfolio and investment teams based in New York and Tokyo. In part two of this interview, he discusses what it's like leading Aflac’s Global Investments team through very challenging periods, Aflac's asset allocation strategy and the three main trends that he foresees in the investment environment.
Eric Kirsch was named on Trusted Insight's 2018 Top 30 Insurance Chief Investment Officers. You can read part one of Eric's interview with us here.
Trusted Insight: How have the investment policies changed since joining Aflac over six years ago?
Eric Kirsch: My time at Aflac has been one great journey. Despite market volatility, particularly, if you think about Aflac, more than 70 percent of our business sits in Japan with Japan liabilities. Unlike a lot of other U.S. CIOs that just have a U.S.-based business, the Japanese fixed income market matters a lot to me. We have a U.S.-based business, too, of about $12 billion, but when I think of my global portfolio, I think about the currency markets over the last six years. This includes activity from the central banks, Bank of Japan, European Central Bank, Federal Reserve, divergent policies and more.
All of those things have had a profound effect on our investment strategy. And I am proud to say that because of the global team I manage, we have been able to navigate through the market environment and further evolve our investment strategies and policies to take advantage of the market and avoid risk at the same time.
For example, when I joined Aflac six and a half years ago, it was a difficult time for our investment portfolio. The European financial crisis had impacted the investment portfolio. So when I came in, I was charged with building out a global investment function, and we opened new offices in New York and Tokyo that now report to me. I redesigned the entire investment process and function, from people to technology to risk management. More importantly, we had to very actively manage the credit risk that existed in Aflac’s portfolio.
At the same time, I had to develop new investment strategies that were different than the past ones to ensure we had a solid foundation over the long term. That is when we did our first strategic asset allocation. The big change besides “de-risking” and “right-sizing” the credit exposures we had – and implementing new investment teams, new guidelines, and new risk management – was developing what we call the dollar-based investment strategy for Aflac Japan. This strategy meant we would not be exposed only to Japanese government bonds and yen private placements, but we created a more robust, more diversified fixed income U.S. portfolio that also had currency hedging attached to it.
All of the changes turned out to be right at the time, which resulted in a huge strategic impact. Our shareholders, policyholders and regulators appreciated everything my team did as we stabilized the situation while also finding opportunities to invest.
Fast forward a couple of years to 2016 when Governor Kuroda, on behalf of the Bank of Japan, introduced the negative interest rate policy for Japan. He brought Japanese government bonds all down to zero. That was a big challenge for us because when more than 70 percent of every asset that we put to work resides with the Japan liability, investing at zero percent, or at a negative rate, was not something we desired to do. It is obviously not ideal to pay out money on our investments.
Aflac’s Global Investments team had to navigate through that very challenging period. And at the same time, from a currency standpoint, hedging costs were increasing. That was a headwind for us because if you have higher hedge costs, you have lower income, and it is more expensive to hold those dollar assets. We reacted to that environment and shifted our strategy in longer duration investment grade corporate bonds to floating rate assets.
We already had some bank loans, but we then moved our strategy to the private markets – in particular, middle market loans and transitional real estate. We like these strategies because they had credit involved, and we had already built a global credit team.
An important factor at this point was that the income of floating rate securities is based on LIBOR. We liked that because our hedge costs were also highly correlated with LIBOR. We also knew back in 2016, LIBOR was heading upwards from a U.S. perspective, and our hedge costs were heading upwards, and LIBOR was a common denominator with the floating rate assets. In effect, we had net investment income that would be more stable since coupons and hedge costs have been highly correlated, plus we could earn a credit spread.
That was a big strategic shift for us in how to run our dollar assets. And a strategic shift reacting to the Bank of Japan negative rate policy, because we didn't want to put money in a zero, negative, or ten basis point Japanese government bonds. We preferred to keep the assets in dollars for Aflac Japan. We had to have an investment strategy that would address zero yields in Japan, rising hedge costs and yet still allow us to earn positive net investment income.
We have four different investment managers for those asset classes and approximately $5 billion invested between bank loans, middle market loans and transitional real estate. Having a global team along with world-class asset managers provides Aflac with great intellectual capital, human resources and investment experts. We are able to effectively analyze the markets, the situation, our liabilities, and capital and develop an investment strategy that we believe in for Aflac.
Trusted Insight: Aflac’s allocation strategy is very focused on fixed income. Do you allocate to public equities and private equity as well?
Eric Kirsch: We have an allocation to both public equities and private equity. We have an allocation to public equities in Japan and the U.S. Over the course of the last year or so, we have cut the public equity allocation back by about 30 to 35 percent. We felt the risk to equity markets going forward was much greater, and we expected either lower returns or maybe even some sort of correction. We lowered our allocation to public equities, and that has worked out well.
Conversely, we have an increase in our private equity allocation and our real estate allocations. We got our private equity and real estate program off the ground during late 2016. As that portfolio is growing, we wanted to bring down our public equity exposure with a preference for private equity. However, we will maintain some neutral exposure in the public markets.
Trusted Insight: How would these assets positively correlate or negatively correlate?
Broadly speaking, 97 to 98 percent of our investment portfolios are in fixed income. Within fixed income, when we talk about correlation, there is a different correlation between investment grade U.S. credit and a Japan government bond. Typically, there is a low correlation between U.S. fixed income asset classes, like mortgage loans or private debt.
As it relates to public and private equities, the obvious benefit is return. On the other hand, the expected return for private equity is somewhere around 12 percent. Public equity would probably be about 7 percent. From an asset allocation perspective, the clear attraction is earning higher returns over time. For Aflac, the alternative allocation over time might be 2-3 percent. It is never going to be a large portion of our investment portfolio, but that modest allocation provides a bit of an increase in yield at a higher risk. Those asset classes have higher volatility, but a lower correlation to fixed income. They provide diversification to markets over time.
When we think about the economic world and the long-term return, that is where we expect that diversification and return pattern to pay off for us. Month to month or quarter to quarter, a lot can happen, but we are very confident over the long term that our strategy will work from a correlation and return standpoint.
Shorter term, we are prepared for the question, "What if it does not work?" That is why we have enough capital. If it does not work and we have an unrealized loss in market value from equities in a quarter, it is never going to be a number that hurts us because of the diversification and risk standards we have in place. In the long term, the expectation is to increase our return on the efficient frontier from all of our assets.
Trusted Insight: How do you see investment or diversification strategies changing in the next five years? What are some common trends that you believe will play a big part in the allocation strategy?
Eric Kirsch: I foresee three main trends. The first one is the credit cycle will change. We have enjoyed, as I believe most insurers have, a very low level of impairments and losses. When I am in front of the board of directors and our finance committee, I am always saying, "Don't expect these low numbers forever." The credit cycle will turn, there will be higher defaults and losses from a market perspective, and we will have exposure to that. Our impairments and losses are expected to inevitably go up.
I expect that relative to our peers, Aflac’s losses will be lower and well-controlled because of the good credit and risk work that we do. That is how we have managed our platform to be ready for that day. These long bull markets can sometimes lull companies into thinking that this is the norm when it is not. We just enjoyed a really great investment environment that has been very credit friendly.
I am not going to predict how deep and wide the credit cycle may change. I am certainly not thinking anything like the Lehman crisis, but probably something that is just more normal for the business cycle.
The second trend I have noticed is from an asset class perspective. For many decades, we relied on public markets. I think over the next five to 10 years, private markets will play a bigger role versus public markets. Some of it has to do with regulatory changes and some of it has to do with infrastructure. Infrastructure is much needed around the globe and governments do not have budgets to pay for infrastructure improvements. Governments are out of money and are running deficits.
The natural answer is that private capital will play a bigger role in infrastructure projects and investors will have greater opportunity for return in the future. That is just one example, but more of that activity is going to become profound in the investment markets. As an insurance company, we are comfortable with credit risk and being long-term investors because our liabilities are long. We are willing to put in the extra credit work and research required to participate in those markets because we think they will have attractive returns. Time will tell, but I think that could be a trend.
The third trend that could impact allocation strategy is fiscal and macro policies. For the last 10 years, central banks have been heavily influential in the investment markets. Everybody paid attention to the European Central Bank, Federal Reserve and the Bank of Japan. Now, China is playing a much larger role, as well. Central banks have communicated their objectives clearly, and investors are comfortable with the actions and the impacts to markets.
There are some geopolitical influences, as well. Global economies are doing well. For example, the U.S. economy is better, China has stabilized, and the emerging markets are doing well. On the fiscal side, governments still have to tighten their belts as central banks are providing less liquidity and less quantitative easing. How will that impact markets over the next five years? Will we see systemic interest rates going up from the low levels they have been? Will we see the next side of the credit cycle? All of these changes in policy will impact investment markets in the years to come.
View our full catalog of interviews with here.
The complete list of 2018 Top 30 Insurance Chief Investment Officers can be found here.
Eric Kirsch was named on Trusted Insight's 2018 Top 30 Insurance Chief Investment Officers. You can read part one of Eric's interview with us here.
Trusted Insight: How have the investment policies changed since joining Aflac over six years ago?
Eric Kirsch: My time at Aflac has been one great journey. Despite market volatility, particularly, if you think about Aflac, more than 70 percent of our business sits in Japan with Japan liabilities. Unlike a lot of other U.S. CIOs that just have a U.S.-based business, the Japanese fixed income market matters a lot to me. We have a U.S.-based business, too, of about $12 billion, but when I think of my global portfolio, I think about the currency markets over the last six years. This includes activity from the central banks, Bank of Japan, European Central Bank, Federal Reserve, divergent policies and more.
All of those things have had a profound effect on our investment strategy. And I am proud to say that because of the global team I manage, we have been able to navigate through the market environment and further evolve our investment strategies and policies to take advantage of the market and avoid risk at the same time.
"The big change besides de-risking and 'right-sizing’ the credit exposures we had was developing what we call the dollar-based investment strategy for Aflac Japan."
For example, when I joined Aflac six and a half years ago, it was a difficult time for our investment portfolio. The European financial crisis had impacted the investment portfolio. So when I came in, I was charged with building out a global investment function, and we opened new offices in New York and Tokyo that now report to me. I redesigned the entire investment process and function, from people to technology to risk management. More importantly, we had to very actively manage the credit risk that existed in Aflac’s portfolio.
At the same time, I had to develop new investment strategies that were different than the past ones to ensure we had a solid foundation over the long term. That is when we did our first strategic asset allocation. The big change besides “de-risking” and “right-sizing” the credit exposures we had – and implementing new investment teams, new guidelines, and new risk management – was developing what we call the dollar-based investment strategy for Aflac Japan. This strategy meant we would not be exposed only to Japanese government bonds and yen private placements, but we created a more robust, more diversified fixed income U.S. portfolio that also had currency hedging attached to it.
All of the changes turned out to be right at the time, which resulted in a huge strategic impact. Our shareholders, policyholders and regulators appreciated everything my team did as we stabilized the situation while also finding opportunities to invest.
"Having a global team along with world-class asset managers provides Aflac with great intellectual capital, human resources and investment experts."
Fast forward a couple of years to 2016 when Governor Kuroda, on behalf of the Bank of Japan, introduced the negative interest rate policy for Japan. He brought Japanese government bonds all down to zero. That was a big challenge for us because when more than 70 percent of every asset that we put to work resides with the Japan liability, investing at zero percent, or at a negative rate, was not something we desired to do. It is obviously not ideal to pay out money on our investments.
Aflac’s Global Investments team had to navigate through that very challenging period. And at the same time, from a currency standpoint, hedging costs were increasing. That was a headwind for us because if you have higher hedge costs, you have lower income, and it is more expensive to hold those dollar assets. We reacted to that environment and shifted our strategy in longer duration investment grade corporate bonds to floating rate assets.
We already had some bank loans, but we then moved our strategy to the private markets – in particular, middle market loans and transitional real estate. We like these strategies because they had credit involved, and we had already built a global credit team.
An important factor at this point was that the income of floating rate securities is based on LIBOR. We liked that because our hedge costs were also highly correlated with LIBOR. We also knew back in 2016, LIBOR was heading upwards from a U.S. perspective, and our hedge costs were heading upwards, and LIBOR was a common denominator with the floating rate assets. In effect, we had net investment income that would be more stable since coupons and hedge costs have been highly correlated, plus we could earn a credit spread.
That was a big strategic shift for us in how to run our dollar assets. And a strategic shift reacting to the Bank of Japan negative rate policy, because we didn't want to put money in a zero, negative, or ten basis point Japanese government bonds. We preferred to keep the assets in dollars for Aflac Japan. We had to have an investment strategy that would address zero yields in Japan, rising hedge costs and yet still allow us to earn positive net investment income.
We have four different investment managers for those asset classes and approximately $5 billion invested between bank loans, middle market loans and transitional real estate. Having a global team along with world-class asset managers provides Aflac with great intellectual capital, human resources and investment experts. We are able to effectively analyze the markets, the situation, our liabilities, and capital and develop an investment strategy that we believe in for Aflac.
Trusted Insight: Aflac’s allocation strategy is very focused on fixed income. Do you allocate to public equities and private equity as well?
Eric Kirsch: We have an allocation to both public equities and private equity. We have an allocation to public equities in Japan and the U.S. Over the course of the last year or so, we have cut the public equity allocation back by about 30 to 35 percent. We felt the risk to equity markets going forward was much greater, and we expected either lower returns or maybe even some sort of correction. We lowered our allocation to public equities, and that has worked out well.
"For Aflac, the alternative allocation over time might be 2-3 percent. It is never going to be a large portion of our investment portfolio, but that modest allocation provides a bit of an increase in yield at a higher risk."
Conversely, we have an increase in our private equity allocation and our real estate allocations. We got our private equity and real estate program off the ground during late 2016. As that portfolio is growing, we wanted to bring down our public equity exposure with a preference for private equity. However, we will maintain some neutral exposure in the public markets.
Trusted Insight: How would these assets positively correlate or negatively correlate?
Broadly speaking, 97 to 98 percent of our investment portfolios are in fixed income. Within fixed income, when we talk about correlation, there is a different correlation between investment grade U.S. credit and a Japan government bond. Typically, there is a low correlation between U.S. fixed income asset classes, like mortgage loans or private debt.
As it relates to public and private equities, the obvious benefit is return. On the other hand, the expected return for private equity is somewhere around 12 percent. Public equity would probably be about 7 percent. From an asset allocation perspective, the clear attraction is earning higher returns over time. For Aflac, the alternative allocation over time might be 2-3 percent. It is never going to be a large portion of our investment portfolio, but that modest allocation provides a bit of an increase in yield at a higher risk. Those asset classes have higher volatility, but a lower correlation to fixed income. They provide diversification to markets over time.
When we think about the economic world and the long-term return, that is where we expect that diversification and return pattern to pay off for us. Month to month or quarter to quarter, a lot can happen, but we are very confident over the long term that our strategy will work from a correlation and return standpoint.
Shorter term, we are prepared for the question, "What if it does not work?" That is why we have enough capital. If it does not work and we have an unrealized loss in market value from equities in a quarter, it is never going to be a number that hurts us because of the diversification and risk standards we have in place. In the long term, the expectation is to increase our return on the efficient frontier from all of our assets.
Trusted Insight: How do you see investment or diversification strategies changing in the next five years? What are some common trends that you believe will play a big part in the allocation strategy?
Eric Kirsch: I foresee three main trends. The first one is the credit cycle will change. We have enjoyed, as I believe most insurers have, a very low level of impairments and losses. When I am in front of the board of directors and our finance committee, I am always saying, "Don't expect these low numbers forever." The credit cycle will turn, there will be higher defaults and losses from a market perspective, and we will have exposure to that. Our impairments and losses are expected to inevitably go up.
I expect that relative to our peers, Aflac’s losses will be lower and well-controlled because of the good credit and risk work that we do. That is how we have managed our platform to be ready for that day. These long bull markets can sometimes lull companies into thinking that this is the norm when it is not. We just enjoyed a really great investment environment that has been very credit friendly.
I am not going to predict how deep and wide the credit cycle may change. I am certainly not thinking anything like the Lehman crisis, but probably something that is just more normal for the business cycle.
The second trend I have noticed is from an asset class perspective. For many decades, we relied on public markets. I think over the next five to 10 years, private markets will play a bigger role versus public markets. Some of it has to do with regulatory changes and some of it has to do with infrastructure. Infrastructure is much needed around the globe and governments do not have budgets to pay for infrastructure improvements. Governments are out of money and are running deficits.
The natural answer is that private capital will play a bigger role in infrastructure projects and investors will have greater opportunity for return in the future. That is just one example, but more of that activity is going to become profound in the investment markets. As an insurance company, we are comfortable with credit risk and being long-term investors because our liabilities are long. We are willing to put in the extra credit work and research required to participate in those markets because we think they will have attractive returns. Time will tell, but I think that could be a trend.
The third trend that could impact allocation strategy is fiscal and macro policies. For the last 10 years, central banks have been heavily influential in the investment markets. Everybody paid attention to the European Central Bank, Federal Reserve and the Bank of Japan. Now, China is playing a much larger role, as well. Central banks have communicated their objectives clearly, and investors are comfortable with the actions and the impacts to markets.
There are some geopolitical influences, as well. Global economies are doing well. For example, the U.S. economy is better, China has stabilized, and the emerging markets are doing well. On the fiscal side, governments still have to tighten their belts as central banks are providing less liquidity and less quantitative easing. How will that impact markets over the next five years? Will we see systemic interest rates going up from the low levels they have been? Will we see the next side of the credit cycle? All of these changes in policy will impact investment markets in the years to come.
View our full catalog of interviews with here.
The complete list of 2018 Top 30 Insurance Chief Investment Officers can be found here.