Indeed, investors are taking notice of the importance of defensive positioning. Even with the rebound in stocks this year, our research shows that flows into defensive exchange traded products are outpacing flows into all products as a percentage of assets under management (see Figure 1). U.S. listed fixed income ETFs have garnered nearly twice as much as equity flows year to date…Here are a few ways investors can add targeted defensives exposures to their portfolios.
Minimum volatility strategies historically have reduced risk in down markets compared to the broader market and Q4 2018 was no exception.
- The MSCI USA Minimum Volatility Index outperformed the S&P 500 Index by more than 600 basis points (bps, or 6%) in the fourth quarter of 2018.
- Min volume also worked well in other regions: The MSCI Emerging Markets Minimum Volatility Index outperformed the MSCI Emerging Markets Index by more than 900 bps in 2018.
It is worth noting that minimum volatility strategies historically have tended to perform well both in growth slowdowns and in outright recessionary market conditions. Investors may also want to consider high quality dividend paying stocks, which can offer potential income as well as some resilience in down markets as well as adding so-called “safe haven” countries such as Switzerland and Japan.
2. Fixed Income
- The Federal Reserve has raised interest rates nine times since the tightening cycle began 2015. Investors, who were looking to take advantage of those hikes added exposures to short-term fixed income assets.
- However, with the market expecting just one more rate hike [in] 2019, investors concerned with slowing growth or geopolitical turmoil may want to consider longer duration Treasuries (ten years or longer). Historically, these have offered some buffer for portfolios in serious market downturns, as well as a chance to potentially pick up some extra yield.
Historically, commodities have tended to provide meaningful diversification and inflation hedging benefits.
- For example, from April 1991 to March 2019, the annual returns of the S&P GSCI Index have had just a -0.13 correlation to the US Treasury 10 year benchmark index and a 0.25 correlation to the S&P 500 Index.
- In addition, many commodity assets, such as gold, are priced in dollars, and historically have performed in line with an increase in inflation expectations. Therefore, they may serve as an inflation hedge in a portfolio. In the current environment we don’t expect a major increase in inflation, but holding inflation hedges.
Some may question where cash fits into a defensive portfolio:
- While investors generally hold relatively high levels of cash, as the BlackRock Investor Pulse survey has shown, this buffer is increasingly being reallocated to other high quality fixed income options such as U.S. Treasuries as a way to earn incrementally higher yield…
There’s an old saying, “You should fix your roof when the sun shines.”
- we don’t expect a recession in 2019,
- we still believe stocks will continue to climb and we prefer them over bonds
- but the kind of volatility we saw in the fourth quarter could reappear, the result of any number of unforeseen events. When or if that occurs, it would be wise to ready.