AIA Group (OTCPK:AAGIY) is a comprehensive L&H insurance pick from Hong Kong. The economics are good, with a lot of premium renewals, on top of new business. While the operations look good, the investment backend is where we have worries. A lot of it is in Chinese securities. AIA itself is listed in Hong Kong. There are geopolitical risks, as ownership by foreigners from a hostile nation may not be respected, and the situation of Chinese debt could be subject to geopolitical forces. Considering all this, the valuation is not terribly compelling. We don’t think China is especially investable, which is unfortunate because AIA has some otherwise interesting ASEAN exposures.
AIA isn’t entirely China-exposed. They have meaningful business across ASEAN in addition to HK and China.
VONB growth is strong across all regions, but especially China and Hong Kong. A lot of it is due to new partnerships to win contracts, but also reopening activity. VONB will burgeon the policies in force and help drive higher sustainable revenue growth. The business is highly recurring and resilient.
The OPAT per share has yet to rise commensurately growing only 4%. The business is proving resilient from general economic strife in China especially as is typical of the insurance business model.
Our main concern is on the reserve portfolio. They have a large fixed income allocation.
Of that fixed income allocation, a lot of it is government bonds, and there is a substantial allocation to mainland China. Around 10% of assets invested are Chinese government bonds. There would be more within the corporate debt allocation as well.
It’s important to be aware what sort of risks you’re taking when buying an asset. The AIA business is rather unimpeachable just looking at fundamentals, but there are dangerous exogenous factors that need to be considered. The instruments of economic nationalism are government coffers and capital controls. Any stock listed in Hong Kong, and any securities in China, may not be secure at all if it becomes expedient to break contracts. Capital controls could be instituted that may affect the liquidity of Chinese and Hong Kong assets including stocks and bonds, affecting reserve portfolios, especially in its purpose to back up potential claims, as well as the trading of AIA and related securities. Chinese government debt could become a target as well in retaliation by countries opposed to China’s national agenda, and the main sore point that could become a catalyst for serious capital impairment of all assets in the region is the Taiwan question. While it may not be very tenable to make an attempt to invade Taiwan, China would take the opportunity even at substantial economic cost and damage to goodwill. They have already proven that they are willing to damage goodwill as it is, being subject to the chip bans and other maneuvering that is clearly favouring some of China’s neighbours now as an offshoring destination, namely Vietnam. China has been a beneficiary of globalisation but is willing to change its course to take steps that bring it closer to bringing Taiwan back into the fold.
This discussion is of remote risks. The chance of a Taiwan invasion over the next couple of years is somewhat small, but it is by no means negligible, certainly not in the economic damage it would do, and therefore must be considered. The P/B of AIA is above 2x. That is generally considered to be a pretty pricey P/B. While the growth profile would otherwise justify that sort of number, an HK business needs to be considered carefully given geopolitical risks. We think there are quality insurance companies, even those in more vigorous and less mature geographies, that can come at lower prices. Our opinion is very low of investments that get tied up in China, especially with so many alternatives.
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