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Should You Buy Insurance ETFs Now?

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Taking many investors and analysts by surprise, interest rates in the U.S. have moved southward this year despite the initiation of QE taper. Persistently soft job growth, housing start as well as the fear of a gradual cease in cheap dollar inflows thanks to the QE taper and the resultant emerging market lull encouraged risk-loathing investors to flock to safe haven U.S. government debt (read: 3 Bond ETFs Kick Off 2014 with Strong Inflows).

Also, the slowdown in the world’s second largest economy, China, and the escalating turmoil in Ukraine bolstered the demand for safe haven assets pushing yields lower. While this has spread cheer in the market, some sectors like insurance were hit hard.

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 until maturity rewards investors with the face value price, leading to no material loss for bondholders (read: A Comprehensive Guide to Insurance ETFs).

However, the present interest rate scenario is following an opposite trend with long-term interest rates falling more steeply than the shorter ones. In the first two months of the year, yield on the 10-year Treasury note slipped 11.3% in the year-to-date frame while yields on the one-year Treasury note dipped 7.7%.  This has weighed on the insurance industry lately, though many have rebounded to start March.

Is it a good entry point?

Probably yes. With the Fed seems steadfast in curtailing its massive monetary stimulus, rates are likely to rise in the coming days. Though higher demand for government bonds has kept the interest rates under control for now, the scenario is unlikely to persist when the bond buying spree bottoms out. Further, a scale-back in QE means stronger economic growth which will lead to higher demand for various insurance services.

Given this bullish outlook, the recent dip can very well serve as a buying opportunity. Thus, a look at some of the ETFs in the insurance industry could be a good way to target the best of the segment with lower levels of risk. In this space, any of the ETFs can prove to be a prudent choice as all are buy-ranked options (Read: Best ETF Strategies for 2014).

SPDR S&P Insurance ETF (KIE)
Launched in November 2005, KIE looks to track the performance of the U.S. insurance stocks. The ETF has assets worth $294.8 million, and the product holds 51 securities with an equal weighted approach. The product charges a reasonable 35 basis points per year in fees (read: Inside The Top Ranked Insurance ETF).

In terms of holdings, over 38% of the assets are invested in the property and casualty insurance sector followed by 22.6% holdings in life & health insurance. Due to the equal-weight methodology, no stock accounts for more than 2.49% of the basket. The fund carries a Zacks ETF Rank #2 (Buy) and a medium level of risk. 
iShares U.S. Insurance ETF (IAK)
Launched in May 2006, IAK tracks the Dow Jones U.S. Select Insurance Index. The product invests about $151.7 million of assets in 67 securities. It charges investors a little more at 45 basis points a year in fees. The ETF carries concentration risk.
From a sector perspective, it is skewed toward property and casualty insurance firms with investments of nearly 47.8% of the asset base while life insurance companies account for nearly 36% of its assets. In terms of individual stocks, AIG accounts for about 12% of the fund’s assets, followed by MetLife with nearly 10% and Prudential Financial with over 7%.

With a medium level of risk, the fund holds a Zacks ETF Rank #2.  
PowerShares KBW Property & Casualty Insurance Fund (KBWP)
This fund is an unloved choice by investors having amassed just $16 million in assets so far. It closely tracks the KBW Property & Casualty Index, a modified market capitalization weighted index, which seeks to reflect the performance of approximately 24 property and casualty insurance companies. The product charges a reasonable 35 basis points per year in fees.

The fund has company-specific concentration risks. Allstate Corp occupies the top position with over 8% of its assets followed by Travelers (over 7%) and Progressive Corp (over 7%).
The fund holds a Zacks ETF Rank #2. 
PowerShares KBW Insurance Portfolio (KBWI)
KBWI follows the KBW Insurance index. This often overlooked product invests $12.6 million in assets in 24 holdings. The product charges investors just 35 basis points a year in fees.

More than half of its assets are invested in the top 10 holdings. MetLife occupies the top position with nearly 7.82% of its assets trailed by Prudential Financial (about 6.58%) and Travelers (over 6%).
It carries a Zacks ETF Rank #2 and a low level of risk.

Bottom Line

While movement in interest rates has been a key issue for insurance companies, build-up of underlying strength will also likely to send the sector higher. Insurers now have ample liquidity to engage in new projects.

Consistent earnings growth and decelerating combined ratios from most of the primary insurers speak of strengthening fundamentals of the sector. Thus, investors can easily buy in on the sector to enjoy the mid-to-long term capital appreciation.

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