This chart explains why QBE Insurance Group Ltd shares have crashed

Credit: Federalreserve

Shares of global insurer QBE Insurance Group Ltd (ASX: QBE) have taken a beating since the start of 2016, falling more than 23%. Although most shares on the ASX have also been knocked down pretty badly, the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) as a whole is down just over 10% in the same time.

Investors may be wondering why is there such a large discrepancy?

There has not been any major natural disasters during the last few months and the company hasn’t released any new market sensitive announcements either. On top of that, most analysts are still forecasting strong growth over the next few years and the consensus is that the shares are undervalued.

So what gives?

I believe the answer lies in the chart below:

Source: Google Finance

Source: Google Finance

This chart shows a three-month comparison between the share price of QBE and the market yield of 10-year US treasury bonds. As can be seen, there is a very close relationship between the movement of the bond yields and the share price of QBE. The yield has fallen dramatically in the last month in response to investors flocking to less riskier assets and QBE’s share price has followed suit.

In fact, if this chart is expanded over a five year period, as shown below, the relationship is just as clear.

Source: Google Finance

Source: Google Finance

Although there are periods where the relationship is temporarily dislocated (such as in 2012), the longer term trend is obvious when looking at the overall picture.

While some investors may think the near identical fall of QBE’s share price and falling treasury yields is just coincidental, I think this is something QBE shareholders need to be wary of.

So why is this important for QBE and how does this relate to treasury yields?

QBE should be considered as two separate businesses. The first is well known to all investors – its insurance and underwriting business.

The second is its investment division.

When insurance companies receive premiums from their customers, instead of that money sitting in a bank account somewhere, insurance companies can invest that money in various assets until a claim needs to be paid out.

As of 30 September 2015, QBE had 85.5% of its US$26.4 billion investment portfolio allocated to interest bearing financial assets. These include assets like government bonds, corporate bonds and short term cash deposits – all of which are affected by movements in the yields of US treasury notes and bonds.

To put this in perspective, a change of just 1% in investment returns for QBE’s portfolio is equal to US$264 million or around AU$377 million. Therefore, the smallest change in yields will have a substantial effect on overall profitability.

It wasn’t so long ago that investors expected yields to increase once the US Federal Reserve began lifting rates, but what has ensued afterwards was predicted by few.

As the three-month chart above shows, the yields have actually been falling this year as investors flock to the safety of treasury bonds and away from the equity markets. This is bad news for QBE shareholders who, at the start of 2015, were expecting yields to increase which in turn would generate higher returns on the company’s interest bearing investments.

Foolish takeaway 

Although the above charts do not present the complete picture as to why the share price of QBE has fallen so heavily, they do go someway in explaining some of the cause behind it.

One thing is certain however, QBE will benefit when yields do eventually increase and with all else being equal, investors should see a corresponding rebound in the share price.

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Motley Fool contributor Christopher Georges has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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