IN LIGHT of the recent volatility in world equity markets, it is no wonder that investors may be feeling a little anxious about their share portfolios.
However, while this provides unease for some, as a professional investor, the bouts of weakness throw up the opportunity to pick up shares in quality companies at bargain prices.
Timing is of the essence and even when watching share price movements 24/7, it is still possible to get it wrong.
In markets such as these it is therefore important to have a good level of diversification in a portfolio. This may occur on a sector level, where investors may hold a variety of stocks from utility companies through to technology stocks and mining companies, or it could occur on a geographical level or in terms varying asset classes.
Whichever way you decide to broaden the scope of a portfolio, one particular investment strategy which has been in vogue over recent years and will likely remain that way until there is further clarity in equity markets is investing in the shares of defensive companies.
A defensive company is one whose sales and earnings remain relatively stable during both economic upturns and downturns. They may lag behind other companies during periods of economic expansion due to the relative stability of the demand for their products and services.
On the flipside, while the demand for some goods and services tends to fall during periods of economic weakness, the demand for the goods and services provided by defensive companies tends to remain stable.
In the current low interest rate environment investors are vying for more favourable solutions than holding cash. Defensive equity investments offer investors an attractive alternative, with the potential to grow capital over the longer term while producing an income which frequently keeps pace with inflation.
Of course equity investments can go down as well as up and investors must be prepared to invest for the longer term, generally with a three-year view or more.
Some companies are naturally more defensive than others and those with a durable competitive advantage, such as utility companies and consumer stables, remain favourable in times of weakness.
Even in the deepest of recessions people still need supplies of gas, water and electricity, they still need to buy toilet paper, toothpaste and soap and it is the companies involved in such activities which will remain resilient.
In the UK some of the most defensive companies can also be seen in the pharmaceuticals, tobacco and telecoms sectors where the likes of GlaxoSmithKline, British American Tobacco and Vodafone are among some of the investor's favourites. Taking British American Tobacco as an example, the shares demonstrate low levels of volatility when compared to the market. One would therefore expect the shares to lag the index in bull markets and outperform in weaker markets.
However, the shares also offer a healthy dividend yield and the compounding effect of this, together with the capital appreciation over the last five years, has resulted in a total return of 136% versus a more sombre 0.9% for the FTSE 100 Index.
The merits of holding such defensive companies should therefore not be ignored.
There will of course come a time to consider investing in segments of the market that are more geared into the economic cycle, but until a clearer picture emerges caution and quality remain key.
:: Anna.Matthews@Brewin.co.uk
