Price action for both Aviva (LSE: AV) and Legal & General (LSE: LGEN) has been uninspiring for at least the last year, although this isn’t surprising given the challenges the industry has faced along the way. In addition to contending with the fallout from George Osborne’s pensions shake-up, uncertainty over likely capital requirements under the Solvency II regime (effective January 2016) has provided added impetus for investors to shun the sector.
But with full-year results now in and no calamities reported on regulatory capital, it’s a good time to start refocusing on incomes, liabilities, margins, dividends and macro drivers such as interest rates for clues of what investors can expect this year.
Income investors
Aviva’s acquisition of Friends Life boosted assets under management and regulatory capital, while reducing leverage measures of the balance sheet. However, this is old news and it’s now down to management to achieve the promised synergies and growth if Aviva is to keep the wolves at bay.
Some have doubted Aviva’s ability to integrate Friends Life given its past record on acquisitions, while others have expressed longer-term concerns over persistently deteriorating margins.
Last week management announced that the group had covered its Solvency II capital requirement 1.8 times over and achieved faster-than-expected progress on the integration of Friends Life. According to the release, synergies to date now sit at £168m, while the remaining £57m should be achieved one year ahead of schedule, at the close of 2016.
Management doesn’t have much of an answer on margin concerns at the moment, except for the same old cliches of ‘cost reductions’, followed by pledges to boost ‘growth’. However, with healthy dividend cover of 2.4 times and a yield equivalent to 4.5% at current prices, the shares could still be worth holding onto for income investors.
Growth investors
Legal & General offers a larger dividend, with a yield of 5.8%, although it’s worth noting that dividend cover of 1.5 times doesn’t leave much of a margin of safety. This could become less of an issue with time if consensus expectations for earnings growth prove well founded.
Management stayed the course in tough markets as others pulled out, while being ahead of the pack on efficiency and an early adopter of digital technology in years gone past. All that could mean these expectations are well placed. L&G’s Liability Driven Investment (LDI) service, a type of investment that seeks to match investment income exactly with pension liabilities, is a now-key growth driver with a dominant position in the market as a result of the above.
Given the industry-wide mismatch in investment incomes and pension liabilities ($9trn globally), left over from yesteryear’s generous final salary schemes and a long-term decline in interest rates, the size of the market for LDI services should also continue to grow for some time.
In addition, L&G’s defined contribution business is going from strength to strength. The government’s auto enrolment scheme has significantly increased the size of the market. Meanwhile L&G’s early adoption of digital technology and its best-in-class fee structure have enabled it to grow total customer numbers on its platform to 1.8m and increase assets under management by 13% in 2015.
Furthermore, with regulatory capital concerns fading into history and the shares still down by 20% over a 12-month period, L&G could also be one to watch in 2016.
