In times of trouble, rush for shelter. We live in times of economic trouble, so is it time for investors to go defensive? And if so, how?
Is there a safe option for investors?
The biggest risk you can take in business is to never take a risk. We live in a world that is changing, and companies that don’t change will be left by the wayside.
Except, maybe there are some sectors, some industries, that don’t change so much. These are your mature industries. And many of the companies that operate in such industries are known as mature companies. Their scope for growth is limited, investing in such companies will never make you rich, but they typically fork out reasonably high dividends — they represent a reasonable return, so maybe it is time to opt for such companies.
An example of a classic defensive stock would be a utility company. We always need water and energy for example; so one option for an investor seeking safety would be to look at companies like National Grid, United Utilities or SSE.
But let’s take a look at these classic defensive stocks. National Grid’s share price is up 16 per cent over the last year, but is barely changed over the last five years, and down 28 per cent since July 2016. Dividends are a tad over five per cent. Nonetheless if I had bought into the company in November 2016, in an effort to reduce risk, I would be nursing a hefty loss. Or take Centrica, dividends make the stock appear very attractive — yield is around eight per cent, but shares are off by around 60 per cent over the last five years. SSE has dropped over the last five years too, but yield is at a similar level to Centrica’s. In all three cases, share price performance has been lousy, but providing you don’t sell, they will have yielded you a tidy return.
And ‘providing you don’t sell’ is the key phrase. That’s the thing about defensive stocks — for providing a steady, maybe even a very attractive source of income, they can be very appealing, but it can all go wrong if you need to sell. Investing in defensive stocks can be a fine strategy, providing you don’t get yourself into a position in which you have to sell.
I do have a concern, however. The combination of falling cost of energy generated from renewables and falling cost of energy storage could be a game changer. Will we always need a national grid? I am not 100 per cent sure we will. Some defensive stocks can be quite risky over the long term.
Other defensive stocks
Or, of course, there are banks.
It is just that an awful lot of companies that fall into the above categories are actually quite risky. In 2008 we found out that investing in banks is akin to putting money on a roulette wheel. As for tobacco companies — well I don’t think I need to spell out the risks. Investors in the US often cite a certain company that sells a certain sugary soft drink. We now know that this drink is bad for us. As it happens, I love a to drink a nice cold Coca-Cola, but I am desperately trying to give it up, and I am not sure that giving the drink a diet twist, will solve health problems. Don’t get me wrong, I think that Coca-Cola buying Costa may well prove to have been a master-stroke. I am simply trying to make the point that risk free is a non-existent option.
Defensive stocks with growth potential
Or maybe we should look at what one might call attacking defensive stocks — like a full-back who doubles up as a winger.
There are companies operating in mature industries that pay out hefty dividends that do have growth potential. I would put healthcare in that category. The combination of big data. AI, genetic science and nanotechnology has the potential to transform healthcare — and some companies, such as GSK, could be beneficiaries. Then again, GSK shares have not exactly put in a scintillating performance in recent years.
It may all boil down to why you are investing. If you need a steady income stream from your portfolio, then defensive stocks which pay out hefty dividends may well be the best option.
If you are worried about uncertain times, fear a possible economic shock, and want to reduce risk, then diversification may be a better way to reduce risk rather than investing solely in defensive stocks.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees