Where does an income investor look when interest rates are on the rise? Try life insurance companies.
Rising rates are usually bad news for interest-sensitive securities such as utilities, telecoms and real estate investment trusts. But, as with the banks, insurers fare much better when rates are on the rise. They not only offer the potential for capital gains but also respectable yields for the most part.
Insurers took a big hit during the Great Recession, with stocks tumbling dramatically. For example, Manulife Financial Corp. (MFC-TSX, MFC-NYSE) was trading at about $42 in Toronto in the fall of 2008. It plunged all the way to $12.90 a share in February, 2009, after the company slashed its dividend. That's a loss of almost 70 per cent for what until then was viewed as a blue-chip stock with limited downside. Today, the stock is still way below its 2008 high, although it has gained more than 100 per cent since its low.
Sun Life Financial Inc. (SLF-TSX, SLF-NYSE) had a similar but less gut-wrenching experience. It dropped from a peak of $55.71 in December, 2007, to $18.33 in December, 2011, a loss of 67 per cent. But unlike Manulife, Sun Life did not cut its dividend, and the stock has rebounded well in the past few years. It is now trading fairly close to the 2007 high, although it has taken more than a decade to get back to that level.
Life insurance companies as a group are heavily leveraged to interest rates. The higher they go, the better it is, because the bond holdings that underpin their invested assets generate better returns. In most cases, the bulk of an insurer's portfolio is in low-volatility government bonds or investment grade corporate issues.
Rising rates also indicate a growing economy, which is good news for the wealth management arm of an insurer's business.
That trend that is likely to accelerate if the economy remains strong, so it's time to add to your life insurance exposure. My choice is the First Asset U.S. and Canada Lifeco Income ETF (FLI-TSX). Here are the details.
Current price: $13.82
Entry level: Current price
Annual payout: 67.6 cents (trailing 12 months)
Yield: 4.9 per cent
Risk rating: Moderate
The security: This ETF offers an equally weighted portfolio of the 10 largest U.S. and Canadian life insurance companies. The managers also write covered call options on a portion of the portfolio to generate extra income.
Why we like it: These are good times for insurance companies, so the upside potential here is positive. Equally important, the ETF provides good cash flow in the form of quarterly distributions.
Performance: The fund gained 11.2 per cent in 2017 and averaged 14.4 per cent annually over the five years to the end of December.
Key metrics: The fund was launched in August, 2013, and now has more than $200-million in assets under management. The management fee is 0.75 per cent, which is on the high side for an ETF. Most of the fund is invested in U.S. stocks such as MetLife Inc. and Prudential Financial Inc. Apart from Sun Life and Manulife, the only other Canadian entry is Great-West Lifeco Inc.
Risks: As we saw in the 2008-09 crash, insurance stocks can be at risk if the economy sinks into recession and interest rates decline quickly.
Distribution policy: In 2017, the fund paid quarterly cash distributions of 16.9 cents a unit.
Tax implications: The company has not announced the tax breakout for 2017. However, in previous years all the distributions were treated as either capital gains or return of capital.
Who it's for: This is a fund for investors who are willing to incur moderate risk in exchange for good cash flow and capital gains potential.
How to buy: The units trade actively on the TSX so you should have no trouble getting a fill.
Summing up: This is a good time to bulk up your insurance exposure. This fund is the easiest way to do it.
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