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What Value ‘Defensive’ Investing? - August 2013



    Traditionally used in portfolios to provide moderate, steady growth with minimal risk, defensive stocks are found in sectors such as pharmaceuticals, utilities, healthcare and consumer staples and, according to ING Investment Management’s mid-year outlook for 2013, stocks in defensive sectors have seen strong inflows in the past few years as a result of steady growth characteristics and attractive dividend yields.

    Ad van Tiggelen, senior investment specialist at ING Investment Management, says: “These kind of equities led the rally; an unusual phenomenon. Given their ongoing scarcity value, we think it unlikely that these defensive stocks will correct significantly.”

    Investment professionals have long argued that investing in defensive sectors is a “losing and underperforming strategy”, because such stocks tend not to fully participate in upturns in the equity markets and only outperform on a relative basis in downturns.

    Clyde Rossouw, manager of the £36.4m Investec Global Franchise fund, says: “The philosophy and the way we think about investments is very much focused on avoiding capital loss. As much as compound interest is the eighth wonder of the world, it only works if you are compounding positive returns. It doesn’t work when the returns are negative – then it can get quite ugly quite quickly.”

    However, according to research carried out by Credit Suisse, when the strategy is used in a long-term investment portfolio, it can be beneficial.

    The research suggests that defensive companies usually have “solid free cashflow yields” and revenues that are only “slightly dependent” on economic cycles, which allows for “secure and attractive dividends” on a long-term investment horizon.

    Thomas Becket, chief investment officer at Psigma Investment Management, agrees that the money entering equity markets has been flooding into high-quality defensive businesses that demonstrate “strong balance sheets and healthy dividend yields”.

    Mr Becket admits he has had a high weighting to defensive sectors in the past few years, playing on what he refers to as the “defensive delights” theme. But he says that in recent months this weighting has started to be reduced in order to focus on “better value, long-term opportunities”.

    “We don’t believe that defensive equities will necessarily be bad performers in the years ahead, but we believe that their best days are behind them,” he adds.

    Schroder Investment Management’s head of global and international equities, Virginie Maisonneuve, agrees: “I don’t think you should be defensive now. Our portfolio continues to be balanced between defensive and cyclical sectors. We look for companies with earnings growth at an attractive valuation, but also showing competitive advantage. For us, it is harder to find those companies that offer the cheap valuation characteristics and the ‘defensive’ quality in telecoms and utilities.”

    But in spite of fund managers suggesting that now is not the time to be overexposed to defensive stocks, a recent outlook statement from Dexia Asset Management argues that there is yet to be a sustainable rotation in the equity sectors.

    It states: “The lack of a significant rotation from defensive to more cyclical sectors is well suited to the current climate of low economic growth and high liquidity.”

    F&C’s global asset allocation team has recently taken a more defensive stance based on a “shift in investors’ perceptions, as well as a faltering in underlying fundamental momentum”.

    Paul Niven, head of multi-asset investment at F&C, explains: “Clearly, investors have been spooked by recent rhetoric from the US Federal Reserve pointing to a scaling back of quantitative easing. Liquidity has been the driving force of the resurgence of markets in the past year and the prospect of central bank support being reduced is leaving some market participants feeling exposed.

    “The readjustments that are currently taking place in the major emerging economies have seen growth rates disappoint. The recent rise in US bond yields is a further negative factor as it could lead to a sharp fall in foreign reserves for emerging market countries and a corresponding loss of investor confidence.”

    Jenny Lowe is features editor at Investment Adviser

    In this special report


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    1. What does Premier Asset Management’s Mr Rees say defensive investing ‘sounds like’?

    2. By how much did the Russell 2000 index correct between March and mid-April, before rebounding as the month progressed?

    3. After gaining 26.6 per cent in 2012, how much were real estate investment trusts in the Russell 2000 up in the first four months of the year?

    4. How many times in the past 53 years, excluding recession-related bear markets, has the S&P 500 index corrected by at least 10 per cent?

    5. Research from Capita Registrars shows second-quarter payouts by UK companies hitting an all-time high with dividend growth of what?

    6. And how much did dividend payouts from US companies rise in the second quarter

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