Home front gains ground as basis for defensive strategies

This has applied across emerging and developed markets but, if anything, defensive stocks in emerging markets have had an even stronger bull run than those in developed markets as investors have sought to take a lower-risk approach to higher-risk markets. But where do the best opportunities lie now?

Investors have prized certain corporate qualities in the past five years. Strong visibility of earnings, for example, has often meant exposure to higher-growth economies, such as those in developing countries. It means the products have had to be all-weather – healthcare or consumer goods, for example. Investors have also liked a reliable and growing dividend.

This has applied to both developed and emerging markets funds. The Aberdeen Emerging Markets fund has had a high weighting (currently 15 per cent) in consumer staples. The Jupiter European fund has a 24 per cent weighting in healthcare stocks, while the Invesco Perpetual High Income fund has a 35 per cent weighting in healthcare and 20 per cent to consumer goods.

The main difference has been in exposure to financials. The Aberdeen fund, for example, styles itself as “defensive”, with a near 35 per cent weighting in financials because generally there is less risk in emerging market financials than there has been with those in developed markets. Defensive funds in the UK and Europe are still largely avoiding financials.

But which is likely to perform better in future – an emerging markets defensive fund or a developed market one?

Reliability of dividends is likely to be important. Research from Capita Registrars shows second-quarter payouts by UK companies hitting an all-time high, with overall dividend growth at 9.5 per cent. Dividend payouts from US companies rose 17 per cent in the second quarter.

Dividend investing in emerging markets is still relatively new, making payouts more vulnerable, particularly at a time when Chinese growth is weakening. Many defensively focused funds, such as Aberdeen or Newton Emerging Income, have struggled in the past three months, languishing near the bottom of the sector.

Jason Pidcock, manager of the Newton fund, says his fund tends to be defensive in a falling market, but recently that has changed: “The fund underperformed a falling market in May. In the declining markets, there was a lot of profit-taking in income stocks.” He says, however, that the falls have “cleared the air” and his fund has started to perform better again. Certainly, more defensive funds are showing stronger performance in the very short term.

There are those who believe there are still pockets of over-valuation at the quality, defensive end of the markets. Ria Nova, product specialist of the Neuberger Berman China Equity fund, gives the example of Hong Kong-listed Chinese equities, particularly in the domestic staples area. However, she believes that in aggregate valuations are now compelling. Emerging markets generally have been out of favour and that has left valuations looking more attractive.

It is difficult to say the same about some defensive developed market companies. Nestlé, for example, now trades on 18.9 times earnings, with a dividend yield of just 2.12 per cent. This may or may not be a price worth paying, but developed market defensives do not have valuation on their side.

David Hambidge, head of multi-asset at Premier Asset Management, says price is still the key to whether a stock is higher- or lower-risk. He has tended to invest in higher beta markets such as Japan and Emerging Markets but for his core equity income exposure is sticking with the UK, believing it is the “most robust and reliable dividend market in the world”.

The UK stockmarket has been kept lower than areas such as the US by the relative weakness of UK growth, but that appears to be shifting.

Toby Ricketts, chief executive of Margetts Fund Management, is considering increasing his weighting to emerging markets and would do so using more defensive funds. He is attracted by the yields on offer there, which can be as high as 5-6 per cent. However, for the majority of equity income exposure, he too is sticking with the UK, believing it to be reliable.

Developing market defensive funds have their attractions, particularly as a lower-risk way into a higher-risk market. For true defensiveness, though, the expert investors are sticking closer to home.

Cherry Reynard is a freelance journalist.