“We’re still all running balanced funds,” he adds, which, after experiencing a downturn, are built to recoup the lost value, and then continue to make gains until the next fat tail strikes. And funds can get carried away in their search for returns. Before the financial crisis, some became so hungry for yield that they bought ‘enhanced’ cash funds, which gave them some exposure to structured credit securities that turned out to be worthless. This is where funds can make big improvements, Henaghan says: by ensuring their defensive exposures stay true-tolabel and don’t lose money. “There you had something that wasn’t defensive, where there was real capital loss,” he says. There is an array of risks that can destabilise defensive portfolios: illiquidity, duration and leverage. But the “big one” is leverage, Henaghan says. In the years leading up to the financial crisis, many assets were increasingly leveraged to boost earnings. But the credit crunch ramped up the cost of debt and consequently sapped companies’ cashflows. And the pain of deleveraging has been felt ever since. Christensen remembers when domestic listed-property trusts were considered defensive.

They provided stable income streams from good assets – until they were compromised by leverage. Duration risk is not so lethal, he says. In a low-growth, deflationary environment, government bonds are great defensive assets. Longdated issues do particularly well in these conditions, and often outperform cash as interest rates fall. This duration risk is also beneficial when markets are rattled and lots of spooked investors buy short-term government debt, depressing yields, Henaghan says. But in the good times, rising interest rates corrode long-term bond yields, and duration works against investors. Currently, the longer-term yield curves for US Treasury debt are extremely steep, Henaghan says, and if interest rates rise above these expectations, longterm debt investors will suffer. Here Henaghan says that defensive exposures, just like growth portfolios, should be purpose-built. Faced with a steep yield curve, portfolio managers running assets for imminent retirees should not be holding a lot of duration risk, because it’s likely their clients will be redeeming their money soon.

He says illiquidity risk should not be ruled out of defensive portfolios. “I argue that infrastructure or direct property assets – if you’ve got low levels of leverage, and have stable tenants or a government employer and 10-year lease – that’s defensive. There’s low volatility in pricing and a stable income stream.” This type of thinking can broaden the range of potential defensive assets for balanced funds beyond cash and bonds. Inside the armouries Sovereign debt from the rich world has for a long time been safe. Investment-grade debt – whose returns are driven by changes in rates rather than company-specific events – serves as a better defensive exposure than credit further down the ratings spectrum, particularly single B and lower, Henaghan says. This is because changes in interest rates are not usually as dramatic as major company events, and are also more predictable. But Europe’s financial stresses are making it clear that developed market sovereign debt is no longer a given investment-grade exposure.