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Henderson High Income Trust plc – Insuring against the economic cycle
The uncertain economic environment presents challenges for investors in equities, as many sectors experience volatility. However, not all sectors behave in tandem and Henderson High Income has identified non-life insurers as one area that could buck the current market trend…
19 Oct 2023
6 minute read
6 minute read
Key takeaways:
- Non-life insurance can offer non-correlated returns to equity markets given it has its own underwriting cycle.
- We believe that cycle has now troughed and profits, cash flow and dividends can recover quickly, which isn’t discounted in valuations.
- The HHI portfolio has considerable exposure to this theme, across three distinctive businesses.
While the equity market experiences cycles, not all sectors experience the same cycles at the same time. Take non-life insurance: although few customers cut this completely in a downturn, the industry is still subject to some cyclicality. However, insurance cycles are more influenced by capacity in the market (i.e. the number of companies willing to offer a policy) and the pricing environment, than by economic growth.
As such, investing in the non-life insurance sector when capacity is reducing, prices are rising, and valuations are attractive should lead to good returns over the medium term, despite the broader economic context. This is the position we believe the sector is in currently – and we have been investing accordingly.
The motor insurance underwriting cycle has been in a downturn since 2019, with poor pricing discipline and stringent regulation putting industry profits under significant pressure. This has been exacerbated by high inflation, which means, for instance, the cost of repairing a car has been more expensive then when an insurance company initially wrote its insurance policy.
However, insurance policies reprice annually meaning that insurers can recoup losses rapidly. With unprofitable capacity exiting the market and price discipline returning, premium prices have been rising. Data from analyst Consumer Intelligence has shown that in the twelve months to June 2023, the average premium has risen by nearly 50%, with inflation-adjusted premiums now sitting at their highest point in six years. With claims inflation now also easing, this should lead to a sharp recovery in profits.
Within the portfolio we own Sabre Insurance, an underwriter in the UK motor insurance industry of typically non-standard risks, such as young or elderly drivers and expensive cars, where there is less competition. The company is disciplined in terms of only underwriting risks when pricing is favourable and suitably compensates for the risks taken. After a very tough 2022, we believe the company could see a sharp recovery in margins and profits, alongside a return to attractive dividend levels given the large price rises the industry is pushing through.
Another way the portfolio has gained exposure to the recovery in insurance pricing – but outside the sector – is through a new holding in MoneySuperMarket.com. The company is one of the market-leading price comparison website in the UK and should benefit from consumers looking to manage their bills among the rising cost of living. Significant premium rises in car and home insurance are likely to lead to higher switching volumes in its insurance segment and, along with the ongoing recovery in travel insurance, should drive strong profit growth. This investment case is underpinned by the company’s high margins, strong cash generation and attractive dividend yield.
Outside of motor and home, similar pricing dynamics can be seen in other insurance markets. Property and catastrophe insurance prices have also come under pressure in the recent past, as alternative investors entered the market in a bid for yield amid ultra-low interest rates. A heightened number of large insurance events – such as hurricanes and wildfires – means these investors have experienced significant losses and have retrenched from the market. For those companies remaining, this has reduced competition while demand has held up: a strong environment for premium price increases. The Guy Carpenter Global Property Catastrophe Index, which measures the rate of change in the price paid for insurance coverage in this market, is up 43% in less than 2 years.
Earlier in the year the portfolio initiated a position in Conduit Re, a specialist property and casualty reinsurer (companies which offer financial protection to insurance companies), with a diversified portfolio of global reinsurance risks. With premium rate increases coming through, the company’s returns and cash flows should be well underpinned over the medium term. Conduit Re’s valuation is compelling, with the company trading at a discount to its net asset value while paying an attractive dividend.
Our focus on finding well-managed businesses that can generate cashflow, but are temporarily out of favour, has led us to look squarely at the non-life insurance sector. Our view is that the insurance cycle has now troughed and can recover quickly, which should provide the Trust with a useful source of diversification away from the uncertain economic environment.
Glossary
Cash Flow(s)
Cash that a company generates after allowing for day-to-day running expenses and capital expenditure. It can then use the cash to make purchases, pay dividends or reduce debt.
Correlation
How far the price movements of two variables (eg. equity or fund returns) move in relation to each other. A correlation of +1.0 means that both variables have a strong association in the direction they move. If they have a correlation of -1.0, they move in opposite directions. A figure near zero suggests a weak or non-existent relationship between the two variables.
Cyclical stocks
Companies that sell discretionary consumer items (such as cars), or industries highly sensitive to changes in the economy (eg. mining).
Diversification
A way of spreading risk by mixing different types of assets/asset classes in a portfolio, on the assumption that these assets will behave differently in any given scenario. Assets with low correlation should provide the most diversification.
Dividend
A variable discretionary payment made by a company to its shareholders.
Economic cycle
The fluctuation of the economy between expansion (growth) and contraction (recession), commonly measured in terms of gross domestic product (GDP). It is influenced by many factors, including household, government and business spending, trade, technology and central bank policy. The economic cycle consists of four recognised stages. ‘Early cycle’ is when the economy transitions from recession to recovery; ‘mid-cycle’ is the subsequent period of positive (but more moderate) growth. In the ‘late cycle’, growth slows as the economy reaches its full potential, wages start to rise and inflation begins to pick up, leading to lower demand, falling corporate earnings and eventually the fourth stage – recession.
Equity
A security representing ownership, typically listed on a stock exchange. ‘Equities’ as an asset class means investments in shares, as opposed to, for instance, bonds. To have ‘equity’ in a company means to hold shares in that company and therefore have part ownership.
Inflation
The rate at which the prices of goods and services are rising in an economy. The Consumer Price Index (CPI) and Retail Price Index (RPI) are two common measures. The opposite of deflation.
Volatility
The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. The higher the volatility the higher the risk of the investment.
Yield
The level of income on a security over a set period, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.
Disclaimers
References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Not for onward distribution. Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. This is a marketing communication. Please refer to the AIFMD Disclosure document and Annual Report of the AIF before making any final investment decisions. Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.
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19 Oct 2023
6 minute read
6 minute read
Key takeaways:
- Non-life insurance can offer non-correlated returns to equity markets given it has its own underwriting cycle.
- We believe that cycle has now troughed and profits, cash flow and dividends can recover quickly, which isn’t discounted in valuations.
- The HHI portfolio has considerable exposure to this theme, across three distinctive businesses.