The SPDR S&P Insurance ETF (NYSEARCA:KIE) is a promising investment option that captures the effects of higher interest rates through exposure to insurance reserve portfolios. As rates rise, the insurance sector tends to benefit, making KIE an attractive choice for investors. In fact, we are overweight on the sector due to the belief that structural factors will continue to support it for some time.
One of the advantages of investing in KIE is its affordability. With an expense ratio of just 0.35%, it is cheaper than some other specialized insurance portfolios such as the iShares U.S. Insurance ETF (IAK) which charges 0.4%. Additionally, KIE has a price-to-earnings ratio of around 9.6x, offering a solid earnings yield of over 10%.
KIE stands out from its competitors by adopting an equal weighting approach and providing more exposure to small and mid-cap insurance companies. This approach adds value to the portfolio without increasing the expense ratio. On the other hand, KIE has less exposure to insurance brokers and reinsurance compared to IAK. Reinsurance companies may carry slightly more risk as they may not receive the same level of support as larger, more systemic insurance companies.
Both KIE and IAK benefit from a higher interest rate environment. While there may be slight impacts on the demand side in certain markets, life and health (L&H) insurance and property and casualty (P&C) insurance are generally resilient. Furthermore, KIE has recently experienced broad-based pricing benefits after the COVID-19 pandemic. Factors such as hurricane season and other events in major US markets support new buying of P&C insurance, making it a favorable time for investments in this sector.
The reserve portfolios of insurance companies stand to benefit greatly from higher rates. These portfolios can roll over their majority short-duration fixed income exposures at attractive rates. With credit risk, short duration yields-to-maturity exceed 6%, and on a risk-free basis, short duration credit yields are above 5%. Several structural factors, including a demonstrated lack of cooling in the job market and the difficulties in beating the last leg of inflation, provide tailwinds for the returns on KIE company reserve portfolios.
Fixed income is a significant part of reserve portfolios, although insurance companies also hold equities, which may be subject to corrections. However, these losses are unrealized until they occur, and the portfolios remain capable of producing income.
In summary, KIE offers a low-cost way to gain exposure to the US insurance sector, which tends to suffer less than the broader market. With its attractive prospects and the continued support from structural factors, insurance remains an overweight sector worth considering for investors.