The Invesco Perpetual manager has been criticised for underperformance, but persisting with defensive stocks has begun to pay off: Woodford’s Invesco Perpetual Income Fund has returned 6.7% over the past three months, against a UK Equity Income sector average of 4.44%, while his High Income Fund has returned 6.88%.
It almost goes without saying that the real challenge is in prolonging that outperformance over the long-term. So is there now a real rotation into defensive stocks, or is this merely a blip for cyclicals? Deutsche Bank equity analysts suggest the former in a note released this morning entitled ‘Defensive Domination’, in which they advise selling calls on defensive stocks.
“Despite weak equity markets, some defensive sectors (food & beverage, healthcare, personal & household) have outperformed, and rallied such that they look technically overbought”, the team says.
They add that the healthcare and food & beverage sectors in particular have seen “extreme stock price movements on the upside”.
Sell call
Notably, the team’s big sell call is AstraZeneca, which remains the largest holding in Woodford’s Income and High Income Funds.
“AstraZeneca has rallied strongly with the sector since disappointing April 1Q results, after weaker-than-expected sales growth of key cholesterol drug Crestor” they said, attributing some of the rally to short-covering.
Others remain more convinced of the attractions of pharmaceuticals. Another long-time advocate of the sector is Bill Mott, manager of the £430m PSigma Income Fund. Pharma stocks represent “outstanding opportunities on a total return basis”, he says.
“In this bracing and uncertain economic environment, dependability deserves a much higher rating. I firmly believe that pharmaceuticals offer this dependability and they are currently greatly undervalued offering an outstanding opportunity particularly on a risk return basis."
“I am as excited about the current situation as I was in March 2000 at the end of the technology bubble."
Fidelity’s Ian Spreadbury is another who has spoken this week of favouring defensives. The manager of the £2.5bn MoneyBuilder Income Fund said he is playing sectors such as pharmaceuticals, telecoms and tobacco; Newton’s Tineke Frikkee is also looking to sectors such as utilities, tobacco and supermarket chains in her £2.7bn Newton Higher Income Fund.
Sector dislocations
But while those managers are united in their belief in defensives as a whole, the discrepancies between their selections may be just as important, according to the Deutsche team.
“There are many interesting dislocations at the sector level this week. Even within the defensive group there has been strong rotation: healthcare strongly outperformed utilities and telecoms, and it also outperformed cyclical sectors such as energy and media. Personal goods was strong versus telecoms”.
The latest fund manager survey from BofA Merrill Lynch adds weight to the rotation theory. “Risk aversion is more evident in strong sector rotation into more defensive areas, such as consumer staples and pharmaceuticals”, the study suggested on Wednesday. The move is particularly pronounced among European fund managers:
“Up to this point, a stubbornly pro-cyclical, risk-on sector allocation had seemed increasingly at odds with investors’ declining macro confidence over the last few months. With sector allocations still somewhat overweight cyclicals at this point, defensive rotation could well have further to run, unless the growth outlook rebounds,” the survey authors said.
Further volatility
Peter Fuller, director of research at Standard & Poor’s, suggests that recent volatility in the commodities space has prompted this switch. The Deutsche team suggest that banks and miners "should be considered for rebound trades", but continued regulatory pressures in the former sector and the sharp price movements seen in the latter may dissuade longer-term investors.
At Standard Life Investments, global investment strategist Richard Batty believes that volatility will impact upon cyclicals in the coming months, a view that has been reflected in the firm’s £7.2bn GARS fund.
“We have bought outright variance in cyclical markets. Our view is that stock market variance is going up higher than the market expects”, he says.
Fuller believes some managers will now attempt a best of both worlds approach: “I expect barbell strategies to become more popular as managers start looking at defensives”, he says. Combining high yielding positions with growth stocks may sound like a sensible play in the current market – assuming, of course, managers are able work out where that growth is going to come from.
