The recessionary backdrop for equities is challenging. And investors are starting to feel the pain of negative performance in their portfolios. Whilst the long term credo of 'stick to the plan' has historically been proven as the right thing to do, on this occasion diversification may not have their back. For this reason, we are seeing lots of research queries on "Defensive Equity Strategies".
Interestingly, the search results display asset managers pointing in different directions. What does defensive equity investing actually mean? There are several routes that investors can take.
Several asset manager papers point to factor investing. And specifically the benefits of low-vol, or minimum-volatility, strategies that are de-sensitised to interest rate changes. They are the popular low beta alternative and there are several investment managers in this category that shine out. The case for this approach is well support academically, and these papers are all too familiar to institutional investors. The more important issue when considering this approach at the start of a recession, is what happens when markets rebound? How will minimum volatility strategies perform. The research on this topic inside RFPnetworks gives different views.
Other investment managers point to value investing. Which, in contrast to what most assume to be true, tend to be concentrated in more defensive industries. Value investing is not all about financial and energy companies as many investors still may think! However, whilst value also has the potential to outperform early in a recession, it also has the potential to underperform on the way out of a recession. Investment manager research inside RFPnetworks suggests that this is a result of the value stock universe as a whole being positively correlated with higher government bond yields. Consequently, as the recession recedes, and monetary policy loosens, value stocks can underperform.
The growth managers are also quick to claim their stake as defensive in nature. Whether this is valid or aimed at minimising redemptions, is a fair consideration. They argue that beyond the de-rated high growth companies, and the collapse of future expectations from the FAANG cohort, lie a wide body of highly profitable, high quality growth companies, that can weather all storms. But not all growth is created equally. The research on the defensive nature of growth stocks is mixed. Pure momentum strategies tend to underperform throughout the recession. In contrast, quality growth tends to outperform throughout the recession. However, as the recession recedes and interest rates fall, growth stocks in general can benefit from a re-rating due to an increase in the net present value of their future cashflows.
Finally there are the traditionalists. These investment managers argue that given the strength of many corporate balance sheets, dividend-focused investing provides the best of both worlds - a hedge that captures up-markets and provides a stable source of income in uncertain times. The research inside RFPnetworks lends support this proposition. The bigger issue here is that not all dividend strategies are created equally. It pays to do in-depth investment manager research to understand the company fundamentals on which these portfolio managers focus. Their differences can be more important than their similarities.
Selecting an investment strategy that creates a defensive portfolio is a complex task. But also fascinating.
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