IAK - IAK: Favorable With Belligerent Economy In The Face Of Rate Hikes

2023-07-01 23:46:22 ET

Summary

• Insurance companies are cash-generative and large short-term maturity fixed income portfolios continue to roll over at increasingly attractive spot rates.
• 2023 has also been a better year for equity markets, so that component shouldn't be a drag on insurers' results in 2023.
• The comprehensive P/E could be lower for IAK, but these are pretty resilient businesses, and P&C markets in places like Florida should be doing well this quarter after hurricanes.

The iShares U.S. Insurance ETF ( IAK ) remains a solid pick. It got a bit jammed up due to correlations with financials, but in general the insurance companies within our coverage all are reporting pretty favourably, and should be in for a great year on the investment side of their portfolios. PEs are somewhat low, but not a screaming bargain, but there is resilience and quality in these cash generative businesses especially as their investment arms should see a much better 2023.

IAK Breakdown

Expense ratios aren't too low at 0.39% , but as a narrow ETF, it isn't too bad. Exposures are US insurance companies, primarily P&C but also L&H covering around 80% of the allocations.

We think there are several factors that help the case for insurance companies. The first is that most have been showing resilient performance. While markets are cooling down, there has been good pricing action generally speaking, and quite a lot of activity in major P&C markets like Florida which continues to be supported by hurricane damage. Q2 should be the quarter in which we see the hurricane response appear in results as the real roofing activity starts to pop. However, it should be noted that not every market is maintaining discipline, and the insurance business is rather competitive. While there had been some years of price action across the industry, the economic pressure is likely to change the pricing dynamics again, although we still believe in the solid model of insurance companies of receiving upfront cash for an increasingly favourable investment arm.

The second is that US stock markets have been performing well since the beginning of the year. Last year equity portfolios within insurance companies were a drag on results. Now they'll be much more favourable. Moreover, a high concentration of short maturity bond investments in insurance portfolios will continue to roll over at attractive spot rates as the US economy remains belligerent and invites further rate hikes further driving returns in the fixed income allocations. While further rate hikes are going to hurt equity markets in all likelihood, the US market is being supported by outsized allocations to AI-related investments that are buoyant on AI hype. The strong rate environment may be a burden on cost of capital, but with large reserve portfolios focused on fixed income, IAK companies should be able to quite easily match those costs of capital in their low-duration investment arms.

Finally, for L&H markets, US demographics remains some of the best in the developed world. Fundamentals for those markets should continue to see secular improvement.

Remarks

The comprehensive PE of the IAK is just below 13x. That's not a screaming bargain, but it offers a good deal earnings yield from a portfolio of resilient businesses. Insurance saw a pretty substantial drop in performance around the SVB collapse, but they are following in the market recovery. In particular, the sector should be revised on the resolution of the dual concern of the debt ceiling and bank solvency issues, where the market for fixed income securities in which insurance companies are heavily invested could have been affected by fire sale activity. These are now concerns of the past.

Overall, when the market recovers, insurance companies doubly recover with both their reserve portfolio hedge of short maturity fixed income paying off at the same time as their equity portfolios. The business fundamentals remain unalarming for the time being, although they are not immune to more pronounced recessionary pressures, at least in some commercially focused markets. We think that for safe, diversified ETF investors, there is no reason to disqualify IAK from consideration.

For further details see: