the government's last-minute deal last week
to raise the debt ceiling and end the shutdown, the United States
avoided the worst case-scenario of a default
, at least, that is, for now. The temporary deal means that
policy uncertainty remains
and we may find ourselves back on the brink of default in a few
It's no wonder, then, that many investors continue to allocate
to so-called "
" investments. However, as I write in the new
paper I co-authored with
Understanding Defensive Stocks and Their
," not all defensives are created equal in all market scenarios.
This is why, before going defensive, it's important for investors
to consider these three aspects of their potential defensive
What they're trying to defend against.
In allocating to defensive stocks, investors will want to be
precise and differentiate between different types of risk.
Investors who are trying to defend against a market correction¸
for instance, would probably want to think about investments
that fit the traditional concept of a defensive stock, i.e. low
stocks whose value should theoretically go down less when the
However, there are other ways to define defensive. Rather than
focusing on beta, investors often look for companies that are
less dependent upon economic growth. Finally, other investors may
want to defend themselves from a particular event,
like rising rates
. The key point is that what you want to own is largely a
function of what you're trying to defend against. The optimal
balance to insulate a portfolio from a market correction may be
different than the basket used to guard against rising interest
At the same time, it's also important to recognize that when
trying to defend against one scenario, investors may be exposing
themselves to another. Case in point: Many of the traditionally
defensive stock sectors, like utilities and consumer staples,
tend to be rate sensitive. So while they may help protect a
portfolio from certain market corrections or a weak economy, they
may not be as effective when a market correction is caused by a
rising rate environment, as was the case this past summer.
How has a company or sector changed over time?
It's also important to recognize that even which stocks fit the
traditional definition of "defensive" changes over time. For
example, while healthcare stocks are viewed as more defensive
today, they were significantly more sensitive to economic and
market conditions 15 years ago and their sensitivity may change
again with the new healthcare law. Similarly, the technology
sector used to be the antithesis of defensive back in the 2000s,
but since then, many of the surviving technology stocks have
become large, reasonably stable businesses. As a result, the
sector is less sensitive now to the market than it has been in
the past. Meanwhile, in contrast,
the financials sector
has moved in the opposite direction and may move again amid
increasing regulations. The key point here is that exactly how
defensive a stock is, and even whether it's defensive in the
first place, actually changes over time.
The cost of the defensive strategy.
Finally, it's important not to overpay while seeking safety.
Insurance is a wonderful thing, but if the cost of the premium is
too high, you may be better off accepting the risk. Today, some
of the defensive sectors,
such as utilities and consumer staples, are
, meaning you may be paying a very large premium to get only
short-term risk mitigation. In my opinion, this may not be worth
it. In a similar way, investors often overpay for a hedge. This
is particularly risky at a time when unconventional monetary
policy is still distorting pricing in many asset classes.
In short, defensive companies and sectors play a vital role in
a portfolio. That said, defensive companies are not a free
Source: Market Perspectives, "Understanding Defensive
Stocks and Their Tradeoffs".
Russ Koesterich, CFA,
is the Chief Investment Strategist for BlackRock and
iShares Chief Global Investment Strategist. He is
a regular contributor to
and you can find more of his posts