The idea behind a defensive-stock strategy is that some stocks are better positioned to hold up well even if the economy contracts.
Recent market downturns have shown that no particular sector/assets can consistently be counted on as defensive during market downturns.
The world of finance is loaded with eye-popping technical concepts and complicated terminology. But some of these ideas can be quite misleading. Words such as secured, certain, stable, guaranteed can give the impression that investment is of low or no risk – this can be misleading if the investment is not low risk.
Similarly, advertisements of higher-risk investments do not always state that they are higher risk. Today’s article highlights a few concepts that I honestly believe are just downright untrue. Here we go.
The first is the Chinese wall concept. The idea is a shorthand for the barrier intended to keep conflicting interests apart at companies (mostly investment banks) where those interests are housed under one roof.
They are supposed to exist between research teams and the investment banking division. But this is impossible. History in finance is littered with stories demonstrating why this concept is just good on paper but impractical to execute or even regulate.
Companies offered favourable stock research in the hope of winning underwriting business in an initial public offering is an often-occurrence. Not sure why this term is still in rotation when even the real China Wall has a lot of holes and peep-holes.
The second misleading term is risk-free assets. When it comes to investing, nothing can be 100 per cent guaranteed.
Yet, many investment houses like to talk about risk-free assets - this is an oxymoron. Even assets such as fixed-interest government treasuries are subject to inflation and interest rate risk – when interest rates rise, bond prices drop.
Worse, supposedly risk-free rates on many government debts in some developed countries have delivered negative real returns for years. In short, no asset is risk-free, nor does it make much sense to talk of the risk-free rate.
Tied closely to this concept is the safe haven idea. Assets such as gold are used a lot here as it is deemed to act as a form of portfolio insurance in difficult times. The reality is gold has failed so many times - the latest being in 2013 when it went into free-fall losing nearly a quarter of its value.
Lastly is the idea of the defensive stock. The idea behind a defensive-stock strategy is that some stocks are better positioned to hold up well even if the economy contracts.
Simply put, there are some things people will always need, both in boom and bust times: food, booze, electricity and health care. So the theory goes that stocks in companies that provide these goods and services are less prone to fall during economic slowdowns.
Among the typical defensive stocks are food, tobacco, household products and utilities. In contrast, cyclical stocks, such as manufacturers and media, tend to move with the business cycle, falling victim to a downturn when the economy slows.
The bottom line is that there’s no easy escape if the market turns bearish. Recent market downturns have shown that no particular sector/assets can consistently be counted on as defensive during market downturns. In the end, investors will have to be even better stock pickers in a bear market.
Mwanyasi is the managing director at Canaan Capital
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