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Time for defensive action?

Concerns on trade wars and slowing growth rates tell us it’s time to protect against risks, says Henna Hemnani, assistant fund manager for the Miton’s multi-asset fund range

With global growth still robust, corporates reporting generally solid earnings, and inflation and interest rates at unthreatening levels, it’s unsurprising that our portfolios are still biased toward cyclical sectors like materials and industrials. These are economically sensitive sectors that tend to perform well in a positive economic environment and have done so since early 2016. Many of these businesses, for example the mining companies, are hard asset businesses that can act as a hedge against rising inflation.

The other important driver in our decision making process is price momentum, and this year we’ve seen the momentum in some of these cyclical sectors fade a little, namely in materials, industrials and financials. This is most likely because of rising concerns around trade wars and some signs of growth rates slowing in several regions, albeit from very high levels. On the back of this we have sold most of our financials and have diversified around our base case exposure to basic industries by introducing some positions we consider to have more defensible growth.

Energy is a sector that appears to be a good diversifier and ultimately quite defensive as it can benefit from many factors, including inflation and geopolitical instability, which can be negative for equities. We’ve been increasing exposure here over the past few months. Energy has been one of the best performing sectors this year and with ongoing supply side constraints we think the momentum in the oil price is arguably underpinned.

The technology sector has been the other standout performer this year.  Many of these companies continue to achieve huge and resilient earnings growth, and this is another sector we’ve been adding to over the year. However, in a sector that’s very concentrated in just a few stocks, and prone to huge individual stock price moves,, we endeavour to keep our exposure very well diversified. Our technology exposure spans the US, Europe and Asia, and from a sub sector perspective is spread across healthcare, industrials and consumer technologies, including both online retail and online gaming. We also try to keep our individual stock risk fairly low by buying ‘boring’ stocks at weights that are sensible in regard to their contribution to portfolio risk, and we never consider index weights.

We do have a small position in some of the more traditional defensive sectors such as consumer staples and infrastructure, but this is limited to companies where the opportunity for consistent demand growth is still very clear to us. It seems only logical to avoid tobacco companies that are struggling to replace the demand for their traditional product with substitute vaping products. Instead, we own consumer facing businesses in India and South Africa that are benefitting from rapid population growth. Similarly we’ve bought some agricultural producers benefitting from the growing challenge of meeting global food demand. In infrastructure, we’ve introduced some hard asset non-cyclical businesses that can also act as a hedge against rising inflation, like pipelines and airports.

The fundamentals are still strong and in this risk-on environment we would still expect risk assets, specifically cyclical equities, to outperform. With that said we have added to some areas we think can defend against rising inflation, to keep the portfolios well diversified.

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