Re-energized Zurich Ready For Downturn

The potential for a downturn has been a constant consideration in both the fund underwriting and direct investing that Zurich Alternative Asset Management has done over the last 18 months. On the fund side, the firm has made sure to investigate whether managers have been through a downturn before, and “what kind and how deep” those downturns were, said Kester, who before joining Zurich Alternative Asset management served as co-CEO at Allianz Private Equity Partners for six years.

Firms that Zurich Alternative Asset Management has backed of late include ten-year-old turnaround firm KPS Capital Partners in New York and 24-year-old San Francisco buyout shop Hellman & Friedman. First-time funds launched by managers do sometimes get the nod, as was the case with Excellere Partners, a Denver-based middle market buyout shop. But the founding team had worked together earlier at long-established mid-market specialist KRG Capital Partners. On the direct side the firm has backed what Kester calls “recession resistant” companies, typically ones that sell to other businesses.

“In the frothy market we’ve had, we’ve seen more new managers than at any time since the bubble, and we’ve seen a swell of capital from a variety of different sources,” said Kester, 47. It was too much, too fast, he said, and some of the high premiums paid for companies are looking less and less smart—particularly given debt loads that grow heavier by the day. “Some of what was consumed, people may be choking on.”

New Group

Zurich Alternative Asset Management’s focus on long track records contrasts with its own short history. Founded at the beginning of 2006, the subsidiary came together after its Swiss parent, Zurich Financial Services, decided that its hodgepodge approach to investing in private equity—it had no central management or a dedicated amount to invest—wasn’t working. Indeed, Kester said that that mishmash effort, which began in the 1990s, was “running down” to a period of almost no activity by earlier this decade. “We may be seen as a new entity, but we’re really somewhat of a restart.”

The newly formed Zurich Alternative Asset Management, which includes private equity, hedge funds and real estate, has been making up for lost time. Already, in two years, the 32-person firm manages $6.3 billion in exposure across the three asset classes. Kester’s five-person team has invested between $500 million and $600 million across 15 fund managers and 9 co-investments alongside fund managers. Kester anticipates that that pace will consistently, albeit conservatively, grow in coming years. Altogether, the private equity group manages approximately $2.1 billion across 38 funds and 30 managers, half of them from a legacy portfolio that the group inherited from Zurich Financial. Its direct investments account for slightly a quarter of its invested capital.

Beyond backing firms with experience across investment cycles, Zurich Alternative Asset Management is particularly interested in backing international firms. “We haven’t been extraordinarily active yet in Europe or Asia, but we’ve made some initial investments and will make more,” said Kester. The private equity group is most excited about Japan. Though he highlighted challenges, from regulatory impediments to the reality that many Japanese companies—often including hundreds of subsidiaries—simply don’t come up for sale, Kester also pointed to evidence indicating that Japanese companies are 40 percent less profitable than their European and U.S. peers. That makes them great candidates for operational improvements. “We think there’s a tremendous buyout opportunity there,” said Kester.

Zurich Alternative Asset Management also has a taste for mid-market firms that specialize in industries such as transportation, media and technology, including technology LBO shop Francisco Partners, as well as firms that invest in distressed debt and turnarounds. “In the last few years, good companies have been over-levered,” said Kester. “Even if that weren’t the case, managers make mistakes and we believe there’s always the potential for upside with good turnaround managers.” Two beneficiaries of that thinking have been Marlin Equity Partners, an El Segundo, Calif.-based spin-off from Gores Group, and KPS Capital Partners.

The firm remains much less enthusiastic about early-stage venture capital—“it’s overcapitalized and has been for a while,” said Kester—as well as the upper-end of the buyout market. “A lot of money has been made [at mega-funds] in the last several years, but we question whether the tide has floated all boats,” Kester said. Moreover, as an LP that’s ultimately making bets on people, Zurich Alternative Asset Management isn’t thrilled at the prospect of backing firms that have become “multi-product, often multi-asset-class, managers.” In such cases the individuals at the helm, Kester said, “spend a lot less time on investment returns and a lot more time managing their different products.” He added: “We don’t benefit from that fee generation.”

Centralized Approach

Now working together under a single umbrella, the heads of each alternative investment team—David Tsung heads the hedge fund team, Chris Halabi heads the real estate team—meet at least once a week with the Zurich Alternative Asset Management CEO David Wasserman and CIO Ron Cacciola. The cross-pollination “definitely adds to the quality of our due diligence,” said Kester, adding that the firm “hired very experienced people who know their respective [asset classes] and the people in them.”

Instead of turning to buyout shops to seize on distressed trading opportunities, for example, the firm decided, after sifting through internal data, that it would do better to shop for those prospects via its hedge fund managers. In another instance, Kester said that last year he was close to backing a firm that he admires and that had brought aboard several partners to initiate a new strategy. Before pulling the trigger, however, members of the hedge fund team came up with intelligence about the firm that made Kester reconsider the investment. The decision not to back the firm was difficult, but it’s one Kester said he doesn’t regret.

Like many LPs, Zurich Alternative Asset Management also takes advantages of the resources of its parent. Zurich Financial is a global insurer with 58,000 employees, a presence in 170 countries, and nearly $200 billion in assets. Kester stresses that Zurich Alternative Asset Management is “purely return oriented—we don’t, nor are we expected, to consider strategic implications for [parent] Zurich.” That said, the parent company recently proved to be a valuable sounding board for the firm before deciding to co-invest in a health care information services business. On a separate occasion last year, Kester’s group was approached by a fund manager facing the decision whether to invest in a software company serving the insurance claims processing market. The group put him in touch with someone from Zurich Financial who knows the area and who was able to help with due diligence. The fund manager ended up moving ahead with the acquisition.