No post-Fed party for insurance ETFs

September 20, 2013 08:21 AM

After the Federal Reserve said Wednesday that its $85 billion in monthly bond purchases will remain in place, U.S. equity markets soared to new record highs.

Using one of those nifty heat maps that are found various places online, investors would have seen a sea of green.

There were some red spots on those heat maps, too, and not just among inverse and volatility ETFs. Finding sector ETFs that slumped Wednesday was not a difficult task because they stuck out like sore thumbs. Wednesday's tales of woe for sector ETFs were easily spotted because they were the funds that had been highlighted as beneficiaries of a rising interest environment, something that should go by the wayside with tapering off the table.

Sector ETFs that have reacted poorly to the no tapering news include regional bank and insurance funds, two sub-industries that had rallied as 10-year Treasury yields surged almost 41% from May 22 through Sept. 17.

The SPDR S&P Insurance ETF (NYSE:KIE) and the iShares U.S. Insurance ETF (NYSE:IAK) are up 27.4% and 29.4% year-to-date, respectively. In a no tapering world, however, further upside for these ETFs could be limited, particularly if Treasury yields decline as expected.

Low interest rates pressure net interest income for insurance providers, so it was not surprising to see KIE and IAK soar as rates rose. Life insurance providers, many of which dot the rosters of ETFs like KIE and IAK, are prosaic businesses.

They take in cash from policyholders premiums, distribute what needs to be paid and invest the rest. Higher interest rates and bond yields would have made the companies more profitable for the simple reason that they would have earned more on their excess cash, as Barron's reports.

KIE is an equal-weight ETF so it is not excessively allocated to any single stock. In fact, Lincoln National (NYSE: LNC) is the fund's largest holding with a weight of just 2.54%. However, property and casualty and life and health insurance providers combine for almost 62% of the ETF's weight.

IAK may be even more vulnerable as interest rates rise. That ETF, the smaller of the two mentioned here, allocates over 83% of its combined weight to property and casualty and life insurance providers. For example, MetLife (NYSE:MET) and Prudential (NYSE:PRU) are IAK's second- and third-largest holdings, combining for 16% of the ETF's weight. High-flying American International Group (NYSE:AIG), which does provide life insurance, is IAK's largest holding at 12.5%.

All of those stocks are lower today with MetLife the worst offender with a 3.1% loss. Lincoln National, KIE's top holding, is plunging 4.2%. Torchmark (NYSE:TMK), another KIE top-10 holding and a Warren Buffett favorite is lower by 0.7%.

Bottom line: Declining Treasury yields should benefit a plethora of sector ETFs, just not insurance funds.

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