Invest In Quality Defensives To Beat The Markets In Volatile Times!

Investing in equity markets has been a rewarding experience for those who have been able to read the market moods correctly. Investors who are able to position their portfolio optimally are often the ones who are able to diagnose the market environment correctly. It is a common perception amongst investors that defensive stocks should form a part of any portfolio in a market environment that displays volatility. :In other words, defensive stocks are the ones that need to be relied upon when the markets turn volatile. Defensive stocks are also the ones that do not lose as much value as some of the high beta stocks do when the market is in a correction mode. 

What are these defensive stocks? Should one have defensive stocks in the portfolio in different market conditions? What are the actual benefits of having defensive stocks in the portfolio? 

Defensive stocks are usually the ones that yield a constant dividend and offer stable earnings, regardless of the overall sentiments prevailing in the stock market. These stocks usually have a beta value of less than one, which signifies that the stock price moves less than the market, both during upside and downside. Also, it is found that defensive stocks consistently reflect higher RoEs and a steady dividend yield of over 3-4 per cent. 

The stocks qualifying as defensives mostly belong to the consumer product companies manufacturing food, beverages, household and personal products; healthcare companies and companies providing utility services and technology. These products have a stable and constant demand, mostly unaffected through the various stages of the business cycle. Some of the stocks such as NTPC (with a beta of 0.72), ITC (beta of 0.74) and Infosys Technology (beta of 0.84) are identified as defensive stocks. 

The defensive stocks are beneficial in any market situation as these stocks provide the much-needed stability to the portfolio and can generate steady income in the form of dividends for the investors. 

Why defensives are a ‘must have’ in your portfolio? 

These stocks work as a shield to protect and maintain the original portfolio targets of the investors even during periods of high volatility or a weak economy. The strong cash flow of these companies cushioned by their stable operations aid them to sail through the rough economic conditions and negative market sentiments. Offering higher dividend yield in the face of low interest rates, the resilient business model of these companies survive through the economic storms, unless met by an extreme calamity.

When the market is swimming in indecisive waters, with the pull of bulls and bears tearing it apart, the defensive stocks come to the rescue of the investors. These stocks defy the conventional rationale that good equity returns are always accompanied by higher risk. The defensive stocks, independent of economic growth, provide relative yet substantial immunity to the investors in the face of a dropping market. However, as these stocks provide long term wealth creation opportunities at a lower risk, these stocks underperform and high beta stocks outperform during a bull run in the market. Thus, for optimum equity returns, investors must take decisions keeping the economic cycle in mind. 

Do defensive stocks really provide cushion in tough markets? 

Normally, it is expected that the defensive sector stocks should do well relative to the key benchmark indices during tough times. We studied the performance of the defensive sectoral indices versus Sensex for those years where the key benchmark index has given either negative returns or returns of less than 10 per cent in one year. We find that Sensex since 2000 has on 9 occasions given returns of less than 10 per cent. Out of these 9 years, the FMCG sector index has outperformed the Sensex in 8 years, thus highlighting the advantage offered by the defensive stocks when the markets are turbulent. Especially during years like 2011 and 2015, when the Sensex had delivered negative returns, the FMCG sector managed to deliver positive returns. During other years when the index had fallen sharply, the FMCG sector index had fallen to a lesser extent.

 

Now let us look at the IT index performance. When the key benchmark index had struggled to deliver double digit returns, we find that out of 9 years that Sensex has struggled, the IT index had managed to beat the key benchmark index 6 times. The IT index, along with the Healthcare index, managed to close in the green in 2015 when Sensex was down by more than 5 per cent.

Market outlook 2018 and defensive stocks :- 

With a range-bound market outlook, we believe the defensive sector stocks may do well in the coming quarters as well. In spite of several headwinds such as heightened political uncertainty, rising crude oil prices, possibility of escalating trade war and rising interest rates, the markets may respond in a muted but positive manner to the quality of earnings in the coming quarters. 

The firming up of interest rates though remains the key concern for the markets and market participants would be keenly watching the next RBI move on the interest rates. Says Abhishek Gupta, Chief Economist, Bloomberg, “As growth and inflation undershoot the RBI’s projections over time, the central bank is likely to refrain from further tightening. The monetary policy committee’s June decision to retain a neutral stance supports our view that there will be a long pause on rates.” 

Conclusion 

Every long-term investor needs to restructure his portfolio keeping in mind the market environment. When we see that there are visible headwinds for the markets going forward and the valuations are not cheap, it can be a good idea to add on the defensive sector stocks. In India, FMCG, IT and pharma stocks are considered defensive. Due to severe correction in the pharma space, the valuations of these stocks do look appealing as of now. Several of the pharma stocks are close to their breakout levels. The conservative retail investors who lack expertise in identifying opportunities in the pharma and IT sectors can opt for a Systematic Investment Plan (SIP) in any of the well-diversified sectoral funds that invest primarily in these two sectors. Also, investing in IT and pharma stocks when the Indian rupee is weakening is quite logical. FMCG stocks, even though defensive, can always be a part of a growth portfolio as well. In volatile times, sticking with the defensives will help the investors beat the markets. 

Ritesh Ashar
Chief Strategy Officer, KIFS - Trade Capital 

❝ In the current scenario, it will be better to move to the defensive stocks or sectors like FMGC and IT. In the current year, FMCG and IT indices are marking positive alpha by outperforming the key benchmark index, so investors should move their stance to the defensive stocks such as HUL, ITC and TCS. Even globally, we have seen in the US, S&P and Europe consumption and IT are outperforming the benchmark index and other sectors, as per the available data.❞