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The role of equities in a defensive portfolio

This article is part of
Guide to defensive multi-asset investing

The role of equities in a defensive portfolio

Advisers seeking to create an allocation to equities in an uncertain world are faced with the reality that in the sort of deep recession into which the world is headed, company earnings will fall.

Equities are priced as a multiple of the earnings a company expects to generate in a year, so if earnings are falling sharply, then the valuations of equities will follow suit.  

Mark Jackson, investment specialist at JP Morgan Asset Management, says he is keeping the exposure his funds have to equity markets to a minimum in the current climate, and those equities he does own are large caps, and in markets he believes are less reliant on the outlook for the global economy.

He says: “We expect to see significant disruption to earnings over coming quarters. It is unclear how deep or sustained the downturn will be but as economic activity potentially recovers towards year end, we could see a sharp reversal in the earnings outlook for 2021.

"Within equities we have maintained a preference for the higher quality, less cyclical markets such as the US.”

Treat value shares with caution

Sunil Krishnan, head of multi-asset funds at Aviva Investors, says the present climate is not one in which advisers should take risks by buying the shares of companies that have fallen far in value.

A feature of the decade between the end of the financial crisis and the onset of the Covid-19 crisis was the sharp under performance of value equities relative to growth equities.

This typically happens when economic growth is relatively weak, and bond yields and interest rates are low.

Those economic conditions mean investors focus on the growth rate of businesses, rather than the price paid. 

Charlie Morris, chief investment officer at Atlantic House Investments says the problem with value investing in the near future is that “it’s a style that requires there to be lots of growth in the economy, and we are not going to get that.”

But Mr Flood is somewhat skeptical about the prospects for some of the traditional growth companies, such as those that make consumer goods.

He says: “The problem is that while those companies can still sell products, it is difficult to see how they can grow in future, for example, how they can sell more soap.

"People are buying the amount of soap they need now, which is fine, but they won’t increase the amount of soap they buy in future.”

David Coombs, multi-asset investor at Rathbones Unit Trust Management  says two types of companies will thrive in a recessionary world.

He says the first type will be companies that have very little debt, because one feature of a world in recession is that it becomes harder to raise capital. 

The second type of firm he believes will do better is one whose growth is structural, that is, based on changes in society rather than the health of the economy.