New Strategic Asset Allocation Framework

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Investor day presentation, December 1st, 2011
Deep-dive session – Investment Management

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New Strategic Asset Allocation Framework

  1. 1. Deep-dive session – Investment Management Cecilia Reyes Chief Investment Officer© Zurich Financial Services Ltd
  2. 2. Key messages – Investment Management A clear mission, and a disciplined and structured approach are the basis for long term value creation We continuously refine our investment approach to manage risks and use capital more efficiently Our framework allows us to deal proactively with the challenges of persistently low yields and the debt crisis We are well positioned to deal with market uncertainties and preserve the strength of our balance sheet© Zurich Financial Services Ltd December 1, 2011 Investors Day - Focus on Execution 83
  3. 3. Our ALM-focused investment strategy results in consistent and sustainable excess returns relative to liabilities… Cumulative total investment return against the minimum risk investment strategy 50% 45% 46.1% 40% 41.0% 35% 30% 25% 20% 15% 10% 5% 0% Q1 03 Q4 03 Q3 04 Q2 05 Q1 06 Q4 06 Q3 07 Q2 08 Q1 09 Q4 09 Q3 10 Q2 11© Zurich Financial Services Ltd Total return on minimum risk investment strategy Total return on investment strategy December 1, 2011 Investors Day - Focus on Execution 84
  4. 4. … also compared to peers throughout the crisis Peer Benchmarking Q1 2007 – HY 20111 Performance based on return and risk Ranking based on information ratio4 1 Peer 1 -0.09 1st on volatility of Return2 excess return basis 2 ZFS -0.11 0% 3 Peer 2 -0.12 4 Peer 3 -0.13 Peer 1 5 Peer 4 -0.18 ZFS -5% Peer 2 Peer 5 3rd on 6 Peer 5 -0.23 Peer 4 Peer 7 excess Peer 8 7 Peer 6 -0.29 return Peer 3 Peer 6 Peer 10 8 Peer 7 -0.32 -10% basis Peer 11 9 Peer 8 -0.37 Peer 9 10 Peer 9 -0.38 Peer 14 -15% Peer 15 11 Peer 10 -0.44 Peer 13 12 Peer 11 -0.47 Peer 12 Peer 16 13 Peer 12 -0.48 -20% 14 Peer 13 -0.50 Peer 17 15 Peer 14 -0.65 16 Peer 15 -0.68 -25% Peer 18 17 Peer 16 -0.69 Risk3 18 Peer 17 -0.86© Zurich Financial Services Ltd -30% 19 Peer 18 -1.39 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0 5,5 6,0 Source: companies’ website, financial reports Note: peer universe defined as DJ Global Insurance Titans. Some peers were not included in the analysis due to data availability and quality issues 1 The analysis performed is based on quarterly returns 2007 - 2011. Prior data not available in required quality 2 Return = Cumulative excess returns (chain linked) 3 Risk = Standard deviation of excess returns 4 Modified information ratio is used to account for negative returns December 1, 2011 Investors Day - Focus on Execution 85
  5. 5. Our mission provides a clear focus to steer the portfolio through a turbulent market environment Investment Management’s mission Achieve superior risk-adjusted investment returns relative to liabilities© Zurich Financial Services Ltd December 1, 2011 Investors Day - Focus on Execution 86
  6. 6. We invest based on a clear and shared investment philosophy and through a structured and disciplined approach Clear Systematic investment philosophy and disciplined Manage assets relative Maximize economic value to liabilities Capital markets generally Diversify sources of risk do work and return Clear governance structure© Zurich Financial Services Ltd State-of-the-art investment information solutions December 1, 2011 Investors Day - Focus on Execution 87
  7. 7. Allocation of capital to market/ALM and investment credit risk stands at the beginning of the investment process Risk Allocation of Zurich, as of 1 January 2011 Total RBC estimate: USD 34 billion 8% USD 15.3bn Risk Based 13% Market/ALM risk Capital allocated 37% Investment credit risk to Investment Business risk Management 1% 4% P&R risk3 (IM) Re-ins credit risk Life insurance risk Natural cat risk 23% 6% Operational risk 8%© Zurich Financial Services Ltd 1 Total allocated capital = USD 34bn RBC plus USD 2bn direct allocation to Farmers 2 Includes Other Operating Businesses and Non-Core Businesses 3 Premium & reserving risk December 1, 2011 Investors Day - Focus on Execution 88
  8. 8. We continuously refine our investment approach to manage risks and capital more efficiently Investment Management value chain Asset Liability Analysis Strategic Asset Allocation Tactical Asset Allocation Manager Selection Local Adaptation and Portfolio Construction Security Selection and Trade Execution© Zurich Financial Services Ltd Asset Manager Oversight & Investment Reporting December 1, 2011 Investors Day - Focus on Execution 89
  9. 9. We are taking our ALM/SAA framework one step further by fully integrating risk factors directly into both assets and liabilities Risk factors Typical insurance balance sheet exposures Assets1 Liabilities1 Zurich net exposure Equity Risk Liquidity Risk Equity Liquidity Risk Risk 8% Interest Rate Risk 21% Interest Term Structure Risk 9% Rate Risk 48% 14% Commodity Risk Term Credit Structure (Spread) Risk Credit (Spread) Risk Risk© Zurich Financial Services Ltd 1 Darker shades indicate higher exposures December 1, 2011 Investors Day - Focus on Execution 90
  10. 10. The framework allows the management of investments based on risk factor exposures and expected alpha in a fully integrated way Risk factors Translation into selected asset classes1 Passive Active Sovereign Corporate Real Equities Equities Bonds Bonds Estate TAA2 Equity Risk Liquidity Risk Interest Rate Risk Term Structure Risk Commodity Risk Credit (Spread) Risk© Zurich Financial Services Ltd Alpha 1 Simplified illustration with some asset classes missing 2 Tactical Asset Allocation December 1, 2011 Investors Day - Focus on Execution 91
  11. 11. The enhanced framework will lead to more comprehensive, transparent and explicit SAA decisions Risk factors Asset classes Optimize Beta Risk Factor Exposure Optimize Alpha (Budget Allocation) Equity Risk Tracking Error Budget Liquidity Risk (relative to risk factors) Interest Rate Risk Excess return + = relative to Term Structure Risk liabilities Information Ratios by (active) Commodity Risk Asset Class Credit (Spread) Risk© Zurich Financial Services Ltd Capital All risk factors ‘compete’ for Beta budget + All asset classes ‘compete’ for Alpha budget  allocated to investments December 1, 2011 Investors Day - Focus on Execution 92
  12. 12. Managing economic risks on a more granular basis under the enhanced framework allows to protect the strength of our balance sheet Risk factors Examples Exposure Assets Liabilities Net Delta Long Short Long Equity Risk Vega Long Short Short Liquidity Risk Exposure Assets Liabilities Net Interest Rate Risk Delta1 Long Short Short Gamma2 Long Short Short Term Structure Risk Vega3 Long Short Short Commodity Risk Exposure Assets Liabilities Net Credit (Spread) Risk Delta Long Short Long© Zurich Financial Services Ltd 1 First order sensitivity to underlying risk factor 2 Second order sensitivity to underlying risk factor (convexity) 3 Sensitivity to implied volatility December 1, 2011 Investors Day - Focus on Execution 93
  13. 13. Where securities cannot be used to hedge ALM risk, derivatives are used selectively Interest rate convexity in the German Life book USD USD USD USD MCEV (excl. MCEV (RHS) Swaptions) Swaptions MVA (LHS) + = MCEV (incl. Swaptions) MVL (LHS)© Zurich Financial Services Ltd -150 -100 -50 0 50 100 150 -150 -100 -50 0 50 100 150 -150 -100 -50 0 50 100 150 Interest rate shock in bps MCEV: Market consistent embedded value; MVA: Market value of assets; MVL: Market value of liabilities; RHS: Right hand scale; LHS: Left hand scale December 1, 2011 Investors Day - Focus on Execution 94
  14. 14. The enhanced ALM/SAA approach… Provides a comprehensive, robust and transparent framework for investment decisions Captures risk factors such as liquidity and term structure risk that are highly relevant in an insurance context Requires us to be explicit about risk and return expectations, e.g. alpha potential for actively managed asset classes Enables us to manage economic risks more accurately through selective use of derivatives where cash securities are ineffective© Zurich Financial Services Ltd December 1, 2011 Investors Day - Focus on Execution 95
  15. 15. Key messages – Investment Management A clear mission, and a disciplined and structured approach are the basis for long term value creation We continuously refine our investment approach to manage risks and use capital more efficiently Our framework allows us to deal proactively with the challenges of persistently low yields and the debt crisis We are well positioned to deal with market uncertainties and preserve the strength of our balance sheet© Zurich Financial Services Ltd December 1, 2011 Investors Day - Focus on Execution 96
  16. 16. Appendix – IM achieves transparency of and focus on core capabilities through a clearly defined value chain Value Chain and Core Competences Earn risk-free investment return by understanding Create effective Asset Liability Analysis the risk-free investment position and efficient governance for Define the long-term SAA based on allocated risk investments Strategic Asset Allocation capital Manage strategic Earn market risk premia innovation and Generate skill-based returns based on market leverage central Tactical Asset Allocation strategies value levers Operations Select high performing asset managers at right Define and price implement HR Manager Selection Systematically monitor and act on manager strategy performance Define and Local Adaptation and Ensure efficient implementation of investment implement Portfolio Construction strategies Communication strategy Security Selection and Monitor alpha generation by internal and external Effective Trade Execution specialist asset managers investment© Zurich Financial Services Ltd planning and Asset Manager Oversight & Provide timely, high quality information for management of Investment Reporting decision making in the investment process budgets December 1, 2011 Investors Day - Focus on Execution 97
  17. 17. Appendix – Where securities cannot be used to manage certain ALM/Market risks effectively, derivatives are used selectively Examples of specific ALM/Market-related implementation action using derivatives Starting Point Implementation 1 Very long-dated interest rate risk Systematic portfolio restructuring German traditional with- Liability analysis revealed substantial and purchase of long-dated EUR profits endow- negative convexity zero-coupon government bonds ment book (since 2008) Swaption programme (started 2010) 2 Long-dated and convex interest rate Long term CHF receiver swaptions Swiss traditional with-profits risk due to long-dated CHF liabilities portfolio (started 2006) endowment book with embedded options 3 Large and convex exposure to both Dynamic equity and interest rate US run-off variable annuity book interest rates and equity markets hedging (started 2010) 4 Future fee income from unit-linked Short forwards on major equity indices UK unit-linked fee assets is exposed to declining equity (started 2009)© Zurich Financial Services Ltd income markets 5 Asymmetric risk profile of Eurozone Purchase of EuroStoxx 50 equity puts Eurozone tail risk sovereign debt crisis tail risk event (started 2011) equity hedge Timely implementation required December 1, 2011 Investors Day - Focus on Execution 98

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