Insurance brokers and securities exchanges hold potential for investors.
It’s probably not surprising that the headline-grabbing woes of regional banks have cast an unwelcome floodlight across the financial sector. The recent abrupt demise of three institutions caught investors flatfooted and sent valuations plummeting throughout the sector, seemingly without regard to the nuances of the industries that make up the sector or the fundamentals of individual companies.
But the sector entails a lot more than banks. It’s quite a diverse grouping of industries, including insurers, securities exchanges, credit rating businesses, investment managers and even firms that facilitate digital payments.
Two of these industries have proven attractive to many Capital Group investment professionals: insurance brokers, which connect consumers to insurers, and securities exchanges, where investors buy and sell financial instruments.
By Rob Grube | Capital Group equity analyst
Risk is always a top concern for investors, but I probably think about it even more than most. My coverage area includes insurance, an industry that’s literally in the business of managing downsides.
On a positive note, insurers have tended to be resilient during economic downturns, in part because coverage — for both businesses and homeowners — is not only important but often legally mandated. That means premiums are often among the last expenses to be cut during belt-tightening.
On the flip side, however, insurers face the threat of large or unexpected claims. Just as banks need a comfortable cushion of liquid assets on hand to meet depositor withdrawals, insurers need ample reserves to cover payouts for natural disasters, lawsuits or other claims.
But there is an adjacent industry that features many of the insurance industry’s compelling traits while steering clear of many of the hefty risks: insurance brokerage firms. Brokers don’t engage in underwriting — that is, they don’t extend the actual coverage or assume the responsibility for paying claims. Instead, they help buyers assess their insurance needs, understand coverage options and sift through prices. Ultimately, brokers place coverage with a recommended insurer, making their money by taking a percentage of the monthly premiums on the policies their customers buy.
Brokers can be thought of as a tollbooth of sorts: They charge travelers but nether maintain the road nor respond to crashes. As a result, they’re not subject to the capital requirements and balance sheet risks that weigh heavily on the insurers themselves.
Brokers aren’t just middlemen. They’re crucial in helping buyers make sense of complex policies couched in legal terminology. I rely on my agent to clarify points in my homeowners insurance, which is far less convoluted than the esoteric policies used by large companies. That makes brokers very important to CFOs, for example — buying the correct kind and amount of insurance ultimately falls to them, and making the wrong choice can be professionally costly.
I don’t want to give the impression that brokers are risk free. The shares of many companies are pricey at the moment, and businesses can struggle to differentiate their services. Still, I think brokers have an attractive risk profile and a lot of long-term potential.
Rob Grube is a Capital Group equity analyst covering property and casualty insurance, asset managers and trust banks. He is also a small- and midcap generalist in North America. He has nine years of investment industry experience and has been with Capital Group for six years.
By Nermis Rosario | Capital Group fixed income analyst
Banks are the classic example of cyclical stocks. Historically, they have done well in strong economic conditions but suffered whenever recessions struck. That’s due partly to loan demand falling and defaults increasing historically when the economy falters.
By contrast, exchanges are countercyclical. They have tended to hold up in periods of volatility, largely because of how they seek to generate revenue. Exchanges facilitate securities trades, matching buyers and sellers and handling the logistics of the resulting transactions in exchange for a fee. What is interesting about this is that trading volume has tended to increase during times of stress as investors look to reposition their portfolios. The bottom line? Exchanges have tended to make more money amid economic uncertainty, benefiting as traders respond to shifting economic policies or market environments.
The appeal of exchanges has been boosted by recent forays into subscription-based and data services. Due to the nature of their business, exchanges generate a tremendous amount of data on market trends and trader sentiment. They have increasingly sought to harness that data and sell subscriptions, including to analytics and indices data, giving themselves revenue streams that are less correlated to market activity. Those advantages are some of the reasons I, as a fixed income analyst, like exchanges.
As with any investment, exchanges are not perfect. While they can benefit from heightened volatility, at a certain point, breaking news, policy shifts and other events can muddy the waters so thoroughly that traders don’t feel comfortable shifting direction. Periods of market paralysis also can weigh on the fee-based portion of these companies’ income. Additionally, exchanges can experience issues through their clearinghouses, which secure collateral to ensure traders can cover their transactions.
Overall, though, and absent any transformational merger activity, I view exchanges as defensive choices. I have found them to be attractive investments during volatile or recessionary periods — something worth considering in today’s economic environment.
Nermis Rosario is a fixed income analyst at Capital Group who follows nonbank financial companies. She has 14 years of investment industry experience and has been with Capital Group for two years.