March 29, 2018 / 1:08 PM / a year ago

Investors back on the defensive, but where to hide?

LONDON (Reuters) - Equity investors looking for protection from tech-led share reversals, trade wars and Europe’s slowing economic momentum may find that the “defensive” sectors they usually seek out during market storms are no longer the safe havens they once were.

A computer screen showing stock graphs is reflected on glasses in this illustration photo taken in Bordeaux, France, March 30, 2016. REUTERS/Regis Duvignau

Earnings of telecom, consumer staples and healthcare companies and utilities tend to hold up when macro indicators turn south, but many of these now face disruptive or competitive forces that threaten their traditionally robust income streams.

“‘Defensive value’ stocks have become a very small niche this cycle. Those that appear defensive and not aggressively priced typically have some structural or regulatory issues,” said Paul Harper, equity strategist at DNB in Oslo.

Big European telecom firms for instance are struggling to get hoped-for returns from their investments in broadband and mobile infrastructure as smaller rivals nip at their heels with simple, cheap data plans.

And competition rules and the lack of a unified European telecom market are making defensive mergers hard to pull off.

Utilities face similar challenges and are also grappling with weak wholesale energy prices, an increasingly redundant model of centralized power generation and the cost of building new networks to manage a rapid switch to renewables.

Tobacco companies are pushing new technologies but they are at a relatively early stage, the results are patchy and it is unclear whether they can offset the gradual decline in revenue as more smokers kick the cigarette habit.

And the food industry is going through unprecedented upheaval as big brands face competition from retailers’ own labels and activist investors push for swingeing cost cuts, making it harder for companies like Unilever and Nestle to defend their profit margins.

In healthcare, drug distribution and health insurance face the threat of disruption by e-commerce giants, forcing prices lower even as pressure grows on state health budgets.

“A number of politicians have talked about tighter regulations on pricing of pharmaceutical products which is a risk for defensive healthcare stocks,” said Harper. “In the UK, a change of government could potentially hit some utilities with nationalisation.” 


The recent rise of tech stocks to rule global markets, and the dominance of banks in the rally starting after U.S. President Trump was elected in November 2016, have combined to create a highly cyclically-led market.

“Defensive” sectors look cheaper on some measures than cyclical stocks after rising less during the breakneck equities rally.

Morgan Stanley said on Thursday that European cyclicals were now trading at a rare premium to defensives on price-to-book.

This historically was a reliable warning signal for cyclicals’ price and earnings per share performance over the following 12 to 24 months, MS said.

Investors’ positioning on cyclicals has also begun to look elevated. Barclays found both European and global funds have increased their cyclicals exposure to near the highest levels in the last decade.

Among the best-performing STOXX 600 sectors over the past five sessions are utilities .SX6P and consumer staples .SCOST, which rose while banks, tech stocks and industrials fell.

Those now looking at defensives are being very selective. Chris Dyer, global investment director at Eaton Vance, said investors should look for high quality companies with strong pricing power, including powerful consumer brands and franchises.

“You look at the derating of the defensive sectors and see some good opportunities,” he said.

Angelo Meda, head of equities at Banor SIM in Italy, is adding to positions in Italian utilities, Reckitt Benckiser (RB.L) and Nestle (NESN.S). He also holds German utilities E.ON (EONGn.DE) and RWE (RWEG.DE).

Even tobacco stocks look attractive to some. Saracen Global Income and Growth Fund has bought back into Imperial Brands (IMB.L), a stock that has tumbled 24 percent this year, saying it was generating strong enough cash to maintain its dividends.


Some investors, reluctant to bet on defensives, are looking for protection elsewhere.

“We haven’t made any specific changes, but our portfolio managers have been holding some portfolio insurance in case of a setback,” said Kevin Gardiner, global investment strategist at Rothschild.

The insurance is a mix of put options and third-party funds that either trade volatility themselves, or can deliver uncorrelated returns, he added. “[It] means we have been spared the difficulties of having to choose specific “defensive” sectors – it wouldn’t be easy!”

This reluctance to opt for specific defensive sectors and risk choosing the “wrong” one has also inspired some to look to exchange traded funds.

“The interest in more defensive, high quality, low volatility (factor ETFs), has increased,” said Michael Hunstad, head of the quantitative strategies group at Northern Trust Asset Management. “Investors don’t want to just buy a Utilities ETF, they want something more diversified.”

Additional Reporting by Danilo Masoni; Editing by Richard Balmforth

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