As markets climb a wall of worry asset owners should have a defensive equity strategy in place to help limit losses, delegates heard at Investment Magazine’s Equities Summit.
Greg Kolb, chief investment officer at Perkins Investment Management warned that market selloffs could do irreparable damage to portfolios.“If you lose a little, it doesn’t take too much to get back to even, but drawdowns of more than 20 per cent take a Herculean effort to come back from,” he said on a panel. He added that defensive investing – a Warren Buffet methodology for investing in companies with a margin of safety – was a legitimate investment strategy that super funds should embrace.
Equities are trading near record high as the market shrugged off economic uncertainty that prompted the US Federal Reserve to cut interest rates for a third time this year. The International Monetary Fund has also turned the most bearish on global growth since 2008 and Germany, Europe’s largest economy, is teetering on the brink of a recession.
Panellists at a session on Risk Adjusted Returns: Is Defensive Equities Really a Strategy said asset owners are looking for equities that generate an equity risk premia without the drawdown risk. A defensive equity strategy, they said, allows them to limit losses in moments of stress, participate in the gains over time and achieve compounded higher rates of return with less risk along the way.
Kolb said defensive investing involved much more than simply buying stable businesses with iconic brands, solid margins and low valuations. “The so-called defensive sectors have been bid up in the recent market rally,” he said. “The rally has been a growth-led, quality low volatility rally but as multiples expand, risk rises even in high quality businesses.”
He said his investment team are finding defensive value in a number of less obvious areas. They bought shares in BMW and Wells Fargo even though the former is a cyclical stock sitting within an industry that is undergoing massive structural change and the latter is a scandal-ridden bank whose share price is at a 20-year low. Yet, he says the German carmaker is an iconic global brand with significant net cash and a solid balance sheet and Wells Fargo is one of America’s largest mainstream banks that returns 10 per cent each year through a combination of dividends and share buy backs.
“These elements lend defensiveness to stocks,” said Kolb.
Chris Dixon, a portfolio manager at Cooper Investors, said investing defensively meant searching for companies with recurrent earnings, quality management and a healthy balance sheet. But just as important is the way the stock behaves. “Is it up to the eyeballs in a bunch of low volatility ETF’s? If it is, then when the everything hits the fan it will be anything but low volatility,” he added.
“The point is what’s defensive is not static – it changes over time and equity mangers need to be all over all of these changes all of the time,” said Dixon. “So, they’re not holding something that they think is a rock that turns out to be a hand grenade.”
Dixon pointed to companies like Nestle and Tesco that were traditionally thought of as defensive but which have delivered periods of “pretty horrible” performance due to changing consumer demand and industry deterioration respectively.
Adrian Warner, chief investment officer at Avenir Capital said coming from a strong private equity background, his firm aims to generate an attractive absolute rate of return over time regardless of the market in way that doesn’t expose them to risk of capital loss.
“We take the best elements of the private equity mindset and apply it to the public markets.”