Hong Kong insurance stocks may offer protection from rising interest rates
Higher bond yields help insurers achieve better returns, while the sector has strong fundamentals and is poised for strong growth
While many stocks are vulnerable to the impact on company borrowings of the higher rates introduced by the US Federal Reserve, Chinese life insurers may be one sector that actually benefits.
Recently the Fed raised the interest rate by 25 basis points and provided details of its plan to unwind its US$4.5 trillion balance sheet. It is forecast to further raise rates later this year and another two or three times in 2018.
In response to the normalisation of Fed monetary policy, officials in China and Hong Kong have been lifting their key rates to maintain rate differentials with the US. This helps them to avoid a sharply weaker currency and capital outflows while simultaneously taking regulatory measures to contain asset bubble risks.
China’s 10-year bond yield has risen more than 70 basis points this year to 3.5 per cent, compared to the US 10-year yield which is up just 10 basis points, showing credit conditions are tightening at a faster pace in China than the US.
Elevated policy risks in Hong Kong and China resulting from the Fed’s pending rate increases and shrinking balance sheet, along with high valuations after this year’s stock rally, may make the equity markets vulnerable to a short-term correction. Moreover, recent official data suggest China’s economic growth may have peaked, removing a catalyst for upside surprises in company earnings.
But investors can take profit before re-entering on dips in a vulnerable stock environment and switch to shares with strong fundamentals, fund managers say.
“We favour the insurance sector because higher bond yields and rates can help insurers achieve higher returns and improve their ability to reinvest,” said Frank Tsui, fund manager at Value Partners. His company’s “classic fund”, which invests 3.5 per cent of its holdings in Ping An Insurance, has returned about 22 per cent so far this year. Its other major holdings include SIIC Environment (5.7 per cent), Alibaba Group (5.6 per cent), Taiwan Semiconductor Manufacturing (5.3 per cent) and Kweichow Moutai (4.8 per cent).
Hong Kong’s ratio of insurance premiums to GDP stands at 17 per cent, higher than Japan and Singapore. At the same time, the city’s insurance market has the potential to grow by up to 8 per cent on average per year over the next decade, driven mainly by strong growth in life insurance sales, according to Michael Heise, chief economist at Allianz.
“Hong Kong’s life insurance market has ‘major growth potential’ in at least the next 10 years as people prepare for an ageing society and given its resilience,” Heise said. Hong Kong’s premium income is mainly generated by life insurance policies as the city’s swelling ranks of ageing residents buy protection for their old age.
Allianz forecasts the city’s economic growth will be 2.7 per cent in 2017, the highest in three years and up from 2.0 per cent in 2016, supported by solid growth in China.
Meanwhile a new insurance regulator in Hong Kong, the Insurance Authority, officially took over from the Office of the Insurance Commissioner on June 26, and is expected to work closely with its mainland counterparts on oversight.
The China Insurance Regulatory Commission has said it is cracking down on illegal sales of Hong Kong insurance products to mainlanders that have led to capital outflows and money laundering. The government is worried that purchasing overseas insurance products has become a way for mainland Chinese to circumvent capital restrictions and move money abroad.
However, a lot of insurance companies saw business growth of 30 to 40 per cent in the first quarter because of higher productivity and an increase in the number of agents, and despite the tighter regulatory measures, said Toh Hung Bin, executive director and equities senior research analyst at Bank of Singapore.
Chinese clients have also changed the way they view the insurance sector, increasingly buying the products for protection rather than for savings and investment purposes, Toh said. This trend is improving the sector’s fundamentals.
“Tighter regulations will probably hurt smaller insurance companies, and end up benefiting the big insurers that sell universal life products,” Toh said. “In a market that is vulnerable to rising interest rates and expensive valuations, investors may consider defensive plays including the insurance, telecommunications, environmental and infrastructure sectors.”
Mainlanders have been buying insurance in Hong Kong for their lower fees, wider coverage and bigger range of products. They bought HK$49 billion (US$6.28 billion) worth of life policies in Hong Kong during the first nine months of 2016, representing almost 40 per cent of all life policies sold in the city.