Where bond fund managers are finding pockets of opportunity
Finding compelling investment ideas and solutions in global fixed income markets has hardly ever...
Insurance is a funny thing. It’s the only product that both buyer and seller hope is never used. But much of it is now a requirement by law. So that should mean that, as a sector, with recurring revenues and penalties for those that don’t use its products, it should be pretty resilient in tough times.
But that wasn’t the case in 2020 when the global pandemic turned everything on its head.
“Usually, the insurance sector is seen as something of a safe haven, but that wasn’t the case in 2020,“ explained Nick Martin, manager of Polar Capital Global Insurance fund. “The industry is used to coping with natural disasters, but pandemics are another matter – especially those that are not limited by geography or by time.
“The business model of insurance companies is simple: the premiums of the many pay for the losses of the few. But with pandemics, this diversification doesn’t work – we are all vulnerable. So sentiment was hit hard.
“But people forget that pandemics are often excluded in policies. Underwriters simply can’t take on open-ended exposures. So while there were some underwriting costs from covid – for travel insurance and cancelled event, for example – losses have been manageable.”
Nick believes that 2021 will see a change in how the market views and values the sector. “Covid-19 underwriting losses were manageable and company profits have been supported by expanding margins,” he said. “There is a lag between premium rate rises and the income showing up on a business’ books. This is because most contracts are annual. There are no signs that premium rate momentum will slow, and companies are taking advantage of one of the best underwriting markets in the past 20 years. I expect strong book value growth over the next 4-5 years.”
Companies in the insurance sector can be a good source of dividends and a number of equity income managers are finding opportunities there.
Sid Chand Lall, manager of Marlborough Multi Cap Income, for example, told us recently that he thinks the insurance sector has been somewhat overlooked. “It’s been a bit more fashionable for investors to be chasing the tech and energy sector,” he said, “but the insurance sector has actually been very reliable – its cash flows have become increasingly more resilient.
“And if you look at a subsegment, something like the motor insurers, for example, the claims have actually been fairly low. So there’s a degree of surplus capital building up on balance sheets. And this is true, both for the large companies, as well as the small and mid-cap companies in that sector, where I think it hasn’t been appreciated how much value there actually is.”
Andreas Zoellinger, manager of BlackRock Continental European Income, is also finding opportunities in insurance. He told us: “Utilities and the insurance sector have both been overweight positions for us over the last few years. We continue to see some very good dynamics, very good dividend yields, very good dividend growth, and also most valuations continue to look quite attractive.”
And, further afield in Asia, there are opportunities too. Edmund Harriss, co-manager of Guinness Asian Equity Income, invests in Ping An, one of China’s largest insurers. Translated, the name means ‘safe and well’. “Insurance adoption is relatively low in China and as the economy continues to grow, we expect demand for Ping An’s life and property and casualty products to increase,” he said.
“While Ping An is a large financial company, in some ways it can be viewed as more of a technology company. For example, through Ping An Good Doctor, the company offers online healthcare consultations and through Autohome, Ping An runs China’s largest online dealership platform. Most importantly, these investments into technology increase Ping An’s addressable market. Though 2020 was of course a challenging year, which saw a small decline in net profit, Ping An still increased its final dividend by 8%. Despite the company’s strong operational track record, valuations are relatively undemanding which means the stock offers a decent dividend yield.”
It’s not just the equity of insurance companies that is catching the eye of professional investors.
GAM Star Credit Opportunities specialises in investing in the junior or subordinated debt of investment grade companies (junior debt is debt that has a lower priority for repayment than other debt claims in the case of a company default). The managers believe the chances of investment grade companies defaulting is low, but they still benefit from the high coupon of the higher yielding junior debt. Many of their best opportunities are found in the debt of banks and insurance companies and both General Accident and Direct Line are in the fund’s current top ten*.
The managers of Liontrust Monthly Income Bond are also finding opportunities there. Co-manager Aitken Ross told us, “The insurance sector is cheap and has remained cheap. It is viewed by some as a cyclical industry, but it isn’t. People will continue to insure their house, cars, lives, etc regardless of economic impact. We are investing in those institutions which are very high quality, with excellent interest cover and good credit ratings. We have a 10% overweight in the subordinated part of the sector.
“The industry also has an active regulator that limited the dividend capability and got personnel guarantees from CEOs during the height of the pandemic. This was all very good for bond holders and from a sustainability perspective, also offers security and protection.”
*Source: fund factsheet, 28 February 2021