KIE - KIE: Insurance Is Still A Winner

2023-10-05 18:03:45 ET

Summary

• KIE benefits from higher interest rates and offers exposure to insurance reserve portfolios gaining as they rollover at higher rates.
• KIE equities are not that risky, and benefit from low PEs.
• While there are risks to the equity portfolios at insurance companies, demand side resilience and higher rates on large fixed income portfolios should win out.

The SPDR S&P Insurance ETF ( KIE ) captures the effects of higher rates through exposure to insurance reserve portfolios. As one of the few businesses that benefits nicely as rates rise, we continue to be overweight the sector as we believe structural factors, now borne out in the data, will continue to support the sector for some time and open up chances to get in long-duration fixed income exposures over the long peak in rates in 2024. KIE comes cheap, it's a buy.

KIE Breakdown

The expense ratio is 0.35% , that's below what some other specialised insurance portfolios charge, including the iShares U.S. Insurance ( IAK ) at 0.4% . PE is around 9.6x, so more than a 10% earnings yield off hazarding cash in insurance equities, which are not that risky. P&C is around 50%, L&H is around 25% for KIE. IAK is pretty similar, but more P&C instead of KIE's exposures in insurance brokers and reinsurance.

KIE is different in that it has more of an equal weighting approach with more exposure to small and mid-cap insurance than IAK, which has a much more standard allocation profile. This is more value add, but doesn't add to the expense ratio. On the other hand, reinsurance tends to be a little lower multiple and a little riskier in the grand scheme of things, since they'll be thrown to the wayside in order to support the more systemic companies that buy their reinsurance, as it should be. But any implicit too-big-to-fail support will not be there.

Bottom Line

Both KIE and IAK benefit though in the higher rate environment. While the demand side might be slightly impacted in some markets, L&H and P&C insurance in general tends to be pretty resilient, and it has just come off broad-based pricing benefits from after COVID-19. Moreover, hurricane season and other factors for major US markets supports new buying of P&C insurance for the next year, since the hurricanes were really quite devastating the last few years.

But the reserve portfolios will benefit more than the demand-side will suffer as large reserve portfolios get to rollover their majority short-duration fixed income exposures at phenomenal rates. With credit risk, short duration YTMs are above 6%, and on a risk-free basis short duration credit comes in at above 5%.

We think several structural factors lend tailwinds to the returns on KIE company reserve portfolios.

• Demonstrated lack of cooling in the job market risks the perpetuating component of inflation continuing unabated. This is the primary risk factor as far as the Fed is concerned. Higher for longer improves rates that will come in overtime as short-duration maturities repeatedly roll over. It also allows for higher rates than even now in the short term to benefit portfolio yield. The job opening data will be a precursor to the actual jobs report.
• The last leg of inflation would always be difficult to beat, especially when it's above 3% with no more base effects. Also, oil prices are high due to geopolitical factors. We speculate it is OPEC nations trying to topple Biden in the US, since they were not responsive to Biden's diplomatic courtship already in 2022.

Fixed income is usually the majority of the exposure in reserve portfolios. However, the risks are that insurance companies also hold a fair bit of equities, which could be subject to further corrections. But those losses are unrealised when they happen, and those portfolios are still capable of producing income.

Ultimately, KIE is a low expense way to get some exposure to US insurance, which definitely suffers less than the majority of the market. Insurance continues to be an overweight sector.

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