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ETF News And Commentary

The financial sector gathered strength last year and turned out to be the market’s leading segment. Banks are trying to reclaim their past glory, leaving in the past a disgraceful series of hedging losses and scandals. The uptrend in long-term interest rates thanks to prolonged taper-related speculation also helped the operating backdrop of the sector to a large extent (read: 3 Sector ETFs to Profit from Rising Rates).

Now, with a moderate QE3 tapering put into action and more of it in the cards (if the economic recovery remains on track), a specialized corner of the financial space – the insurance industry – will likely outperform other corners of the sector. The segment is expected to be a beneficiary of a rising interest rate environment.

This is because most insurance companies, in particular life insurance, invest in longer-duration bonds, which enable them to earn more on their investment portfolios from higher interest rates. Although, the value of the bonds keep tanking with rising rates, holding the security till maturity rewards with face value leading to no material loss for the bondholders.

Further, there is a high chance that we will see a lesser spike in inflation-adjusted real rates in 2014 than what we saw last year. Hence, insurance companies will benefit from stronger economic growth and higher demand for various insurance services while seeing a moderate bond price decline.

As per the Zacks Earnings Trend, the Insurance industry – Finance sector’s second largest industry – will see as much as 41% earnings growth in Q4 backed mostly by easy comparisons.

Given this bullish trend, a look at some of the top ranked ETFs in the insurance industry could be a good way to target the best of the segment with lower levels of risk. In order to do this, investors can look at the Zacks ETF Rank and find the top insurance ETF (Read: Best ETF Strategies for 2014).

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the insurance sector, we have taken a closer look at the Buy ranked KIE. This ETF has a Zacks ETF Rank of 2 or ‘Buy’ (see the full list of top ranked ETFs) and is detailed below:

About KIE

Launched in November 2005, SPDR S&P Insurance ETF (KIE - ETF report) looks to track the performance of the U.S. insurance stocks. The ETF has assets worth $446.0 million, and the product holds 51 securities with an equal weighted approach.

Not a single company accounts for more than 2.20% of the basket. Top companies include Genworth Financial (GNW - Analyst Report), CNO Financial (CNO - Analyst Report) and Protective Life (PL - Analyst Report) with a combined share of 6.5%.

The product does not have major concentration risk. The equal-weighted strategy eases out the risk quotient of the fund. Investors have to pay 35 bps in fees for the exposure which is lower than the average expenses charged by the financial equities ETF. 

In terms of sector exposure, the top allocation property & casualty comprise around two-fifths of the total assets followed by life & health insurance making up more than one-fifth of the share. Beyond this, multi-line (14.5%), reinsurance (14.0%) and insurance brokers (10.3%) round out the top five (read: 3 Hot Sector ETFs for 2014).

Style-wise, though the fund has exposure in growth stocks, it mainly has a value tilt which keeps investors away from excessive volatility. Lesser volatility and risks can also be confirmed by the fund’s almost entire focus on large-caps. However, this definitely does not mean low returns for the ETF.

The ETF has come out as one of the best performing products in the financial ETF world in 2013 gaining an impressive 46%, and it will likely continue with its exciting rally in 2014. Notably, over the last one-year period, the return (33%) from KIE outperformed the return offered by the broader financial ETF Financial Select Sector SPDR (XLF - ETF report).

Thus, investors seeking equity appreciation with a moderate level of risk might bet on KIE. The fund is currently hovering near its 52-week high level. The product has a Zacks ETF Rank of 2 or ‘Buy’ rating with a ‘Medium’ risk outlook.

Bottom Line

A stronger overall business climate will lead to a rally in the insurance sector thus benefiting the ETF. KIE could be a winner thanks to its high exposure to the health insurance sector.

Cumulative improvement in the labor market along with healthcare reform will greatly benefit the health insurers. Its other big allocation, Property & Casualty insurers, looks geared for strong growth given the rising premium rates.

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