Guest Q&A With Eric Kirsch.
IAUM: How do you define risk when managing Aflac’s portfolios?
KIRSCH: We approach risk in two different ways, both qualitatively and quantitatively, which then ties back to our business model.
From a qualitative perspective, Aflac’s type of insurance is very unique, offering supplemental income, as well as cancer and disability coverage, which generate strong margins. The business has a very stable underwriting and liability profile. As a result, our investment portfolio requires a conservative approach emphasizing preservation of principal, while earning a competitive rate of income, aligning policyholder and shareholder objectives. We do this in a capital-efficient way given our objectives and liability profile.
From the quantitative approach, we focus on Strategic Asset Allocation (SAA), which calibrates our liabilities, capital objectives, credit ratings, the regulatory environment and other factors to produce optimal portfolio allocations at capital-efficient levels using quantitative optimization models. As you know, 80-85% of our business is in Japan, which adds another layer of complexity. Our SAA gives us guideposts for various asset classes, from which we decide how much capital at risk we are willing to allocate to the investment portfolio. From there, we’re able to cascade into things like risk limits – whether those limits be around asset classes, issuers, our exposure to interest rates, credit spreads or foreign exchange. In addition, there is a separate risk team and governance committees that track our results versus our risk limits. Using both a quantitative and qualitative investment approach results in the best risk-adjusted return, given our risk appetite.
IAUM: Based on that definition, how do you manage the various risks in your portfolios, particularly given their global nature?
KIRSCH: First, we carefully monitor all of these risks and continually model our portfolio through various stress tests to ensure we are within risk limits in multiple economic cycles. In addition, we have global teams monitoring credit, interest rate, and currency markets. From there, we make tactical adjustments to our portfolio allowing us to navigate the ever-changing landscape of global markets.
IAUM: What do you think are the biggest risks facing insurers’ investment portfolios today?
KIRSCH: Taking a broader – macro view – trying to find good relative value amid the continued low-yield environment is the biggest risk factor. Coming out of the financial crisis combined with the quantitative easing by all the Central Banks, caused interest rates to hit all-time lows. Of course, that was a great challenge and much talked about within the insurance industry by various analysts, shareholders and regulators. The focus was on liabilities and a companies’ ability to generate enough yield to meet them.
About two years ago we began to see rates rise, and many were hopeful that we would be in a 3-4% rate environment – which would really help to meet return hurdles. However, rates have gone back down. In fact, as we speak, the ten-year treasury rate is around 2.20%. Still, the greatest challenge is finding good relative value.
Because insurance companies have to be invested, we can’t just sit in cash. Regardless if we have low interest rates and tight credit spreads, everything is expensive. We still need to be fully invested. But, good fundamental credit and structure research can get incremental value within your SAA and risk parameters. I am confident that as an industry, we’ll be fine on the whole. Speaking for Aflac – we have a robust investment process and a robust risk management process. Our business model allows us to have a more conservative investment philosophy, meaning we don’t have to stretch for yield. Never the less, low yields and tight spreads across all asset classes is a major challenge for the industry.
A growing concern is that we’re in the longest bull market we’ve ever had, as well as having minimal impairments over the past few years. At some point the credit cycle may turn, along with the economy, and with that we’ll see a pickup of impairments industry-wide. As a result, we have a defensive posture as we move toward 2020-2021. We’re not calling for a recession, but in such an environment you want your portfolio to be well-positioned to weather any storms that may be coming.
As an example, the economy went into hyper-drive with the tax cuts, and we have had excellent growth since. Profits and employment have been at peaks. It’s hard to see how you stay at peak production forever, especially when in the backdrop you have all these macro challenges: China, trade, Europe slowing down, Japan is still stuck in neutral if you will. At some point our growth will slow. What’s concerning is that growth doesn’t have to go from where it is to recession for us to have a bad market.
What if growth goes from this 3.5-4.0% goldilocks scenario to 1.5-2.0% growth? Are the markets and investors prepared for that? The Federal Reserve has said for two years that they would raise rates, and the markets sold off on that in the fourth quarter when they did. It wasn’t like we didn’t know. They told us they were going to do it.
Let’s just say that the market moves from this 3.5-4.0% growth to 1.5-2.0% growth – that’s maybe enough to have a market correction. We saw spreads widen out in the fourth quarter then come running back in the first quarter, but there may be a cycle where they don’t come running back. If that happens, you could have spreads going to 150-200 bps on investment grade and some BBBs going to below investment grade, creating some forced sellers – particularly insurers because they might not have the capital or the appetite – so it becomes self-fulfilling.
It doesn’t have to be a dark, awful scenario but anything above the recent level of impairments may cause investors to overact. Insurers are well-capitalized by and large and are prepared to handle a normal level of downgrades and impairment activity, but does the market over-react to a change in the cycle? That would be the sort of black swan event that you would be on watch for, if there could be one.
IAUM: What is your view of public vs. private markets going forward?
KIRSCH: I believe on a go-forward basis that private markets are going to be critical to capital formation. When I think about some of the major challenges in the United States such as infrastructure or major projects around the world, governments are already at high-levels of debt. It’s going to be difficult for them to issue more debt to make these very necessary types of investments.
Using that as an example, I think private markets could be partners with public markets to drive some of those initiatives. I also see a world of more innovation coming from both large companies as well as stand-alone, smaller companies. That bodes well for insurance companies – life insurance companies in particular like us – because they have longer, stable liabilities and can afford to take liquidity risk. Fundamental analysis on both the credit and structure of the securities allows us to find good relative value in the private markets.
I believe that the supply of private securities will continue to grow, and the demand will be there. Over the next 10, 20 or even 30 years, I see the insurance sector being a very interesting space, because they have plenty of capital to put to work. From what we’ve seen over the last 2-3 years in middle-market loans/private equity – we’re in the early innings of what is going to be a long cycle of capital formation.
IAUM: How will asset allocation methodologies change going forward?
KIRSCH: We continue to think about how technology will impact the investment industry. We have advanced our own internal models and have come a long way from the days of a simple asset allocation model. We have some exposure to this arena through our activities in the venture capital market.
Some of the innovations include using quantitative science to better understand asset classes and risk factors, using super-charged quantitative engines. These techniques may be able to dive deeper into risk factors, allowing the creation of customized asset allocations, depending on your particular view of markets. They may also be able to better understand sensitivities in your liabilities, as well.
While all that gives us better information, we certainly don’t manage day-to-day based on a model. Sure, models give us guidance, projected outcomes, and guideposts, but when we’re in markets and thinking about our views and economies, we don’t just listen to a model. We do, however, use that information as valuable input, which I think is going to become even more intelligent as innovation and artificial intelligence grows.
IAUM: What is your outlook for financial markets over the next 12-24 months?
KIRSCH: We have a cautious approach going forward. Growth has been very strong in the US and worldwide, but it is now starting to marginally ease. Over the next 12-24 months we will be more conservative, thinking that the economy will slow down – not necessarily a recession though.
We certainly will focus on the consequences of a slowdown. That’s where we worry, and that could be the impetuous for a change in the credit cycle. It doesn’t have to be a deep recession, but any change in the credit cycle causes a change in how investors and we feel about the credit exposure of our balance sheet. If we’re wrong, I don’t think we have missed many opportunities because everything is so expensive anyway. We don’t want to reach for yield, so being a little bit more conservative doesn’t really cost us that much. It just puts us in a better position if the economy swings to lower growth.
IAUM: What role does the nature of your liabilities impact your investment decisions?
KIRSCH: Liabilities are very much considered in that equation and factors into how we’ve set up our modeling for the asset classes that make sense for us. Our products and the type of insurance that we offer are pretty unique, meaning that our liabilities are long-dated and very stable. As a result, we are able to do our strategic asset allocation work while calibrating our investment strategy.
IAUM: What are some of the qualities that you look for when hiring investment professionals?
KIRSCH: There are some obvious things you look at: experience levels, technical expertise, and fit-within our culture. Insurance companies asset managers have unique investment strategies, so fit within this style is important. We want candidates to understand our particular style and make sure they wish to contribute to our results.
Equally as important for us are things like cultural fit within our investment group. We work in a very collaborative way, and therefore we look for team players. About 80% of our assets are based in Japan. Our global team must collaborate effectively. We hire investment professionals who want to add great value to our investment results but who also want to be part of a great company, Aflac.
We’re fortunate to be part of a great organization, a great company with the great heritage – a great culture. Our expression here is ”All Aflac”. Rather than just joining the investment team, you’re joining this wonderful insurance company where investments are very, very important to our ultimate results, while at the same time fitting into the larger Aflac culture is very important, as well.
IAUM: I know that you spend a lot of time working with students at your undergraduate alma mater, Baruch College. What advice do you give college students graduating from now?
KIRSCH: I was just at Baruch a month or so ago to give a talk to a Finance class. What I saw in students’ eyes was something like, ‘this guy speaking here is successful, I’ll never get a job that will get me there’. I can see that in their eyes.
I tell them that getting that first job out of college is the hardest part. Once you get that job, you’re as good as anybody you’re working next to or with. You may think you’re the underdog – there are other students coming out of more prestigious institutions but once you’re in the company you actually control your destiny.
And hard work, with the right moral compass, creates your brand. Once you’re on that floor, there isn’t a manager that I’ve ever known – or myself as a manager – who looks across the floor and says, “What school did you come from?” Once you’re there, you’re there.
What does define you is your work product; how you collaborate, how you brand yourself, and how much you’re willing to put into it. Get yourself a scorecard, you want to get an A+. If you get an A+ across the board, you’re going to have a wonderful career – a wonderful journey.
I tell them that someday you’ll be standing up here talking to a group of students just like yourself. You will write your own history book. What school you went to isn’t going to matter. I know sometimes there is that twinkle in their eye, and they’re scared to death because they think they aren’t coming from the best school. But it’s not true – they are coming from a great school, Baruch College. You may start out as the underdog, but once you’re in the workforce, it’s up to you.
IAUM: You are undoubtedly one of the most well-respected CIOs in the world, but not everyone knows that you started from fairly humble beginnings. How has your background contributed to your success?
KIRSCH: I appreciate the kind comments. First I’m humbled and honored to have this opportunity at Aflac. I served the insurance industry for 17 years or so – I have gotten to learn from so many CIOs, CFOs and CEOs. And, I continue to learn in this position from my team, my peer group and my company as a whole.
Coming from the projects of Brooklyn made me feel like the underdog. But I followed my dreams and knew that I had to work hard to create my own brand. It wasn’t just my hard work. It was also the hard work of the team of people I was managing.
I was fortunate to start managing people at a young age and quickly realized that it was sort of like a band, and I got to be the orchestra leader. I may not have been the smartest person on the team, but I could orchestrate pretty well. To the extent I’ve been able to have success over the years – that was the winning formula, so I followed it.
Lead by working hard, practicing teamwork and collaboration; that speaks for itself and others will be glad to follow your lead. If you’ve done those things right, other things will fall into place.
I don’t think I’ve ever lost that. When we begin new projects – some of which are very difficult – I’ll be right there, side by side, to help lead our team through it. Managing through those difficult times, in large part, has defined my success.
IAUM: What would you tell your 21-year-old self?
KIRSCH: I would tell him to follow his dreams. He will have to work very hard but in the end it will all pay off. I would tell him to find good mentors and take their advice along the way. I would tell him the importance of staying true to his moral compass. I would tell him that if he does all these things, after 20, 30 or 40 years he will have had a very great career – a great journey.
I would also tell him that it’s not all about work. I would remind him to stay balanced with family, charitable causes and helping other people. Most of us have been working for decades in this industry. I don’t share my story to brag, there’s nothing to brag about. But I do want those starting out to know that they can write their own history book and build their own brand, while working with great mentors and bosses along the way.