PA ANALYSIS: Is momentum making investors positively defensive?

As Woodford and Mott turn round poor relative performance defensives may be the place to be.


But where the top fund managers are allocating their money gives an indication of how wise is it to keep faith with defensives.

Since the credit crunch, investors playing cyclicals and absorbing higher prices have done well in recent years as funds with exposure to mining and industrials appearing at the top of performance tables.

Momentum to defensives

But momentum cannot last forever and, as their valuations look increasingly stretched, is a wider exit from cyclicals expected? And if so how likely is a subsequent major re-rating of the defensives that have been so lacklustre recently?

The obvious example to look at is Invesco Perpetual’s Neil Woodford, who has championed defensive sectors such as pharmaceuticals and tobacco and excluded commodity and cyclical names. Such conviction has cost him a heavy performance price on his income funds in recent years but there are signs his positions are starting to bear fruit.

The same goes for PSigma’s Bill Mott who has stuck to his guns in what he describes as the “largely ignored part of the market” now being rewarded and stocks he thought were cheap, such as GlaxoSmithKline, have started performing.

Perhaps the best weathervane for cyclical versus defensive prospects is a genuine business cycle, as per investors such as Julie Dean who runs Cazenove’s UK Opportunities portfolio.

Higher leverage

According to her, the key factor for a company’s performance is the level of fixed costs because with cyclical businesses in consumer or industrial sectors, a higher proportion of costs are fixed. When markets enter the recovery stage of the cycle and sales pick up, there is much more leverage on profits and the company will outperform.

In contrast, more defensive sectors tend to have low fixed costs and therefore little operational leverage, meaning they can adapt their cost base according to demand.

Dean is currently overweight defensive growth sectors and remains heavy in consumer and industrial cyclicals as the market waits to see whether the recent slowdown is temporary. Her key underweight in commodity cyclicals, with the group convinced that current prices are too high and the status quo is unsustainable.

What we are seeing right now is the transition from a momentum-driven market where the pace of upgrades in mining and industrials is slowing, to one where defensive holdings are starting to shine through.


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