The economic and political uncertainties have made it challenging for investors due to the highly volatile situation they created in the global stock markets.
As market players worry about a potential recession worldwide, investors could be considering ways to keep their portfolios safe from a looming economic downturn.
Defensive investing is one option. Here’s what you need to know about defensive investing and how such a method can protect your investments and help you survive a possible slump in the global economy.
Defensive Investing Explained
Defensive investing is a strategy that involves playing it as safe as possible and going for investments that are proven to provide stability.
Investors typically employ such a conservative investing method when the global economy is facing challenging times by rebalancing their portfolios towards assets that can withstand an economic downturn.
With defensive investing, you attempt to minimize the risk of losses and the overall volatility of your investment portfolio.
Volatility gauges fluctuations in an asset’s value over time, which can become a problem if you need to sell some of your holdings when prices are down, even for a short period.
In defensive investing, an investor’s portfolio usually consists of asset classes like low-risk cash and bonds, equities, and assets with less correlation to the stock market, such as gold.
By holding different and uncorrelated assets, you can have a defensive portfolio while possibly making better returns. Still, remember that you should build your investment portfolio based on your risk appetite.
While investing should be considered a long-term strategy, only some investors are willing or able to handle short-term losses and might only be aiming for low-risk investments.
Ways to Invest Defensively
Buying shares in a single or a few individual companies carries significant risk, which exposes investors to potentially detrimental losses if each stumbles.
Such risks can be offset by focusing on particular sectors and then evaluating firms in a certain sector against specific conditions.
Determining a sector
Concerns over a global recession have led investors to retreat from high-growth companies, particularly tech companies, and go for those in less cyclical segments.
The latter includes businesses gaining from the versatile demand for their goods, including essentials like food, drink, and healthcare products, improving their overall outlook during a falling economy.
Sectors such as tobacco, defense, and pharmaceuticals are traditional areas for weathering a recession. However, investors should know that some share prices in those sectors have significantly climbed over the previous year.
That’s mainly because stock markets expect economic developments and, as a result, have already priced in relative difficulty.
It’s important that your investment portfolio doesn’t rely too much on a single company or sector and continues to have balance. In addition, keep in mind that all equities are highly risky, but specific sectors have fewer risks and exposure to the economic cycle, like utilities and healthcare.
Even if you’re on the defense, having a mix of different equity sectors would be good, and then controlling the risk by shifting the whole equity weight in your portfolio.
One way to have more variety in your investment portfolio is to lower the proportion of equities in the portfolio altogether and raise the proportion of other assets, such as cash and bonds.
Choosing stocks
While defensive stocks can tough it out during an economic slump, you still need to practice caution when choosing sectors or companies to bet on.
Going for companies with little or zero debt can be an option. Remember that you should not take the ability of debt to ruin the value of shareholders’ equity in a recession too lightly.
Since the global financial crisis, investors have become less sensitive to the risks associated with high debt due to the long period of low or near-zero interest rates. Now change is observed in the money’s availability and cost. Therefore, caution is a must.
You can also add companies with high levels of repeated revenues to your portfolio, as such firms have a pretty good forecast of their future revenues and can plan costs accordingly.
Another option is businesses with the potential of becoming price-setters, particularly during inflation, because of their dominance in the markets, like Apple Inc. and Amazon.com Inc.
Moreover, more prominent companies could have the financial capabilities to ride out a profit decline better than smaller companies.
Defensive Investing with Funds (Collective Investments)
Investing in funds provides investors with an already-diversified portfolio with more defense-focused assets.
Such funds include absolute return funds seeking positive returns in different market conditions and total return funds seeking protection against losses in declining markets and providing growth ink surging markets.
The portfolios of these funds are more defense-oriented and cover various assets such as stocks, commodities, currencies, and bonds, including derivatives. That kind of diversification helps smooth out the average returns for investors.
In choosing ideal defensive funds, multi-asset funds are one option, as they can give you exposure to stocks, commodities, bonds, real estate, and cash. You also get to work with an active fund manager who moves between the said asset classes.
On the other hand, funds like specialist tech funds, emerging market equities, and smaller company funds carry a considerable risk that you may need to steer clear of. While equity income funds are also risky, they are usually on the lower end of risk for equity funds.
Still, if you really want to minimize risk, the best thing you can do is to retreat from equities and go for assets such as bonds. That way, you have more security and a better risk-reward ratio.
Defensive Investments and a Recovering Economy
Should you reposition your investment portfolio less defensively once the economy starts to bounce back?
If a defensive portfolio has been built properly, it should still be able to gain in absolute terms, although it would slow down a pure equity portfolio.
You can consider rebalancing if the risk and reward for an asset class significantly changed or if the weights are notably different and are changing the risk profile.
