26 Apr 2022
Defensive investing – what is it and what’s the latest market outlook?
Defensive investing is a strategy preferred by many retirees and those with a low tolerance for risk. It can be used to minimise loss and volatility within a portfolio and generate stable ongoing returns.
With inflation on the rise and interest rates tipped to follow suit, many defensive investors are wondering what impact this economic climate might have on their financial situation.
Here we explain what defensive investing is and ask our experts to provide their insight into the market outlook for this class of investments.
What is defensive investing?
A defensive investment strategy usually has the aim of protecting an investor’s wealth, rather than growing it. Defensive investments are lower-risk investments, so they are often preferred by risk-averse investors or those who want to generate a steady income over time, such as retirees.
While defensive investing is a strategy in itself, a diversified investment portfolio will contain some defensive investments to protect against market ups and downs, and even a growth strategy may incorporate a small defensive allocation.
Types of defensive investments
Defensive investments largely fall into two categories: cash and fixed interest.
1. Cash
Cash investments include various types of bank accounts such as high-interest savings accounts and term deposits. In a defensive investment strategy, cash is used to protect wealth and diversify a portfolio. It can also provide a stable income through interest payments.
While cash is often considered the least risky investment, it’s important to understand that the value of your cash investment could be impacted by inflation. If inflation rises quickly, meaning the cost of goods and services increases, your money could buy you less than it used to.
2. Fixed interest
Fixed interest investments include products such as bonds, debentures, and capital notes. They provide investors with a regular income or dividend payment for a specified term. At the end of this term (the product maturity date), the price of the initial investment is repaid to the investor.
Fixed interest products are generally considered low risk and stable investments, however, there are a few things to be aware of before you invest. As is the case with cash, inflation can affect the value of fixed interest investments. If inflation rises above expected levels, the value of your money at maturity may be less than when you initially invested.
Interest rates can also impact the resale price of some fixed interest investments. Take bonds for example. The fixed interest rate paid by bonds will become more attractive to buyers if interest rates fall below the level paid, driving up the price of the bond. On the other hand, if rates rise above the value of the payment, there will be less demand, and thus the bond’s resale price will decrease.
Other “defensive” options
You may have heard of the term “defensive shares”. This term usually refers to shares that have a stable value and provide consistent dividends. While not strictly a defensive class of investment, they may play a role in certain defensive investment strategies, however, be aware that shares generally carry more risk than cash or fixed interest.
What the experts say - defensive investment market update
The PSK investment team have provided their insight into the market outlook for defensive investments
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It's been a particularly tough period for defensive assets over the last 12-15 months. Rising inflation expectations followed by actual rising inflation has resulted in rising bond yields and hence falling bond prices as bond markets try to incorporate ahead of time how central banks might act over the forward period. At the same time, whilst cash has provided capital certainty, returns have been near zero whilst inflation has resulted in the decreased purchasing power of cash.
Whilst no one knows when the current weak period in bonds will end, it appears we’re a fair way through it given how many central bank interest rate rises bond markets are currently factoring in for this year. In addition, whilst bond prices have been weak, bond yields have been rising strongly and now appear to be at very healthy levels relative to their recent history and relative to cash. That means bond investors should expect healthy income in the period ahead along with the potential for some capital gains over the medium term.
Cash continues to provide some utility value in the form of capital certainty and the ability to be used to take advantage of opportunities in other parts of the portfolio as they arise. However, this needs to be contrasted against a decline in purchasing power as inflation rises or remains high.
Overall, defensive assets remain an important portfolio tool for those seeking lower volatility, diversification, and income over different time horizons.
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If you have any questions or your personal circumstances have changed please do not hesitate to contact your financial adviser.
Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
