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The best defence

Defensive is a word being bandied about by a lot of investment people in these crazy market days but the definition appears about as changeable as what classifies a value or growth stock.

One thing many agree on is that financials are not quite as clear cut a holding as they used to be while other areas that were previously thought of as speculative, such as mining and oils, are looking more transparent.

With today’s fund managers taking so many differing approaches to what constitutes defensive, buyers are having to treat funds with even greater scrutiny to determine what strategy is being employed in a market environment few have ever seen before.

Looking at the performance of sectors from technology and mining to tobacco and banks, it is clear that all have done badly in recent months. However, it is the growth sector of technology has done best over three months, according to Trustnet, followed closely by the more defensive pharmaceuticals. Yet over the 12 months to September 24, it is tobacco that wins out, followed by pharmaceuticals and then oil producers. The changeability of the market at the moment is hardly a surprise to anyone.

In many ways, today’s market – separate from the UK economy over which managers seem pretty uniform in their bleak outlook – seems to be driven by sentiment and momentum, similar to the upward drive in the technology sector in 1999 but obviously with the opposite effect.

Like then, fundamentals in individual companies are largely being ignored. Negative sentiment has driven stocks to their most attractive levels, not just in years but in decades. The only problem is that until sentiment changes, it is hard to assess when or if these purchases will come good.

Psigma’s Bill Mott says like with the technology crash, there has been no single defining moment causing the rollover in the market. Instead, he blames falls on a breakdown in sentiment. For example, he notes that the newsflow on miners did not suddenly turn bad, yet share prices fell. “Sometimes these things break down because the momentum has gone too far,” he says.

While agreeing that this has made the market tough, Mott also feels that there are greater opportunities in equities than seen for some time. At the moment, there are no areas of the equity market that Mott considers too expensive, a change from four months ago, when he would have pointed to the natural resources sector. Following sector fallback, overall these days, equities look in the range of mildly expensive to dirt cheap, he says.

With financials having been a mainstay in the past as high dividend payers and with talk of a speculative bubble in commodities and natural resources, it is interesting to see how some fund managers are now playing these two sectors as their roles appear to have reversed.

Royal London UK growth manager Bradley Mitchell thinks the mining and oil sectors are a good place to hide in today’s market. He notes that at least there is an understanding of the numbers from these companies and their business models, which cannot be said any more of sectors such as the banks.

Mitchell is overweight in a lot of natural resources at the moment, believing in the long-term fundamentals of this story and blaming recent price dives on what he terms “commodity tourists”. He says the fundamentals of many metals and oil look very attractive and he continues to like the supply side of the equation in this area of the market.

Mitchell says: “Our position has resulted in performance being difficult in the past few months but I am still confident it is the right view in the long term. It is about fundamentals and valuations.”

This is not to say that Mitchell is without more traditionally defined defensive holdings. He favours tobacco, along with Jupiter’s Tony Nutt and Invesco Perpetual’s Neil Woodford.

Woodford’s income and high-income funds feature two tobacco firms among his top 10 holdings. Nutt and Woodford are also high in other traditional defensive holdings, such as utilities and pharmaceuticals. Utility stocks account for the biggest sector position in Woodford’s funds and in August he reported that he was adding to his stakes in Glaxo as well as AstraZenca.

M&G cautious multi-asset fund manager David Jane has made similar moves. He says: “At the moment, my focus is on defensive stocks, including pharmaceuticals such as GlaxoSmithKline and Johnson & Johnson, consumer non-cyclicals such as Unilever and Colgate-Palmolive and industrials such as Vallourec.”

Mott’s Psigma income fund is neutrally weighted towards traditional defensive stocks at the moment. Instead, he favours domestic cyclicals on the back of the compelling valuations he is seeing. Domestic cyclicals have not been a popular investment area, considering the state of the economic turmoil, but Mott says stocks are discounting an unrealistic level of wealth destruction. “We are seeing a once-in-a-lifetime opportunity to buy these assets at such prices.”

Even managers who have previously weathered hard times in high cash weightings seem pretty committed to investing these days although that is not to say there are not managers out there with higher than average holdings in cash.

The latest factsheets on Stuart Mitchell’s Waverton continental Europe fund and Hugh Hendry’s CF Eclectica continental European fund show that Mitchell’s fund is holding 15 per cent while Hendry’s features less than a 5 per cent allocation to cash. Crispen Odey is holding around 17 per cent cash in his Opus portfolio. Still, even at 15 to 17 per cent, such weightings remain a far cry from the 30 to 40 per cent weightings seen in some funds at the turn of the century.

Amid contradictory forecasts and predictions, one thing is crystal clear. No one knows what is going to happen next. One consistent message from market commentators is the bearish outlook for the economy but how sentiment will drive stockmarkets and investments going forward is anyone’s guess, it would seem.

Maybe it is worth remembering that even if markets fall further, cheap is still cheap. Dire economic predictions aside, one commonality seen among equity fund managers is the belief that equity prices are looking good. Mott says it is difficult to predict market levels but overall he thinks equities are attractive. Mitchell comments that if investors want to put their money in and go away for several years, then now is the right time to be buying. Fidelity’s Anthony Bolton is encouraging investors not to shy away simply because of bearish commentary.


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