“Good quality defensive firms offer opportunities for positive returns”

8th February 2016


David Jane, manager of Miton’s multi-asset fund range explains why there is still quality to be found in defensive stocks…

It has been a difficult start to 2016 with most equity indices giving negative returns.

In fact, markets peaked last April and on a number of measures, many have entered ‘bear market’ territory.

The same can been said about high yield bonds, emerging markets and so on.

On the positive side we can only look to government bonds and gold to have delivered materially positive returns.

Sterling investors have benefitted from recent weakness of the pound partially offsetting overseas asset class level losses. Clearly, it has been a difficult period for investors.

Our strategy is to focus on capital preservation and we think the key to that is to avoid large losses, which at an index level would have been difficult recently, especially in equities.

However, as ever it pays to look deeper into markets. As the old adage goes it is ‘a market of stocks not a stock market’.

When we dig down into the index returns, we discover that over this period of negative returns the majority of the falls are accounted for by a narrow range of stocks and sectors.

The heart of the recent storm has been resources and energy, arguably driven by the maturity of the Chinese growth story leading to a structural over supply of natural resources. Combine this with the large amounts of debt, which the industry has assumed, to fund capital expenditures and even share buybacks in some cases, and you have a perfect storm of capital destruction.

This has widened out to impact certain capitals goods sectors and also financials.

So if we consider the FTSE All Share Index over the past six months, its fall is more than accounted for by losses in financials, basic materials, industrials and energy. Less than half the index accounts for all of the decline. The other half has carried on as before.

The same can be said of other equity indices, the corporate bond markets, high yield bond markets and elsewhere.

During the decline, capital preservation has been as much about what to avoid as what to own. Owning good quality defensive companies has been a strategy to make positive returns even in this difficult market.

At the same time, clients also want to make positive real returns over time and our strategy here remains to look for areas with strong thematically driven growth prospects.

Many companies, even those in industries, which have been poor, have continued to prosper.

Examples include the technology driven growth names such as Google and Facebook or the new energy names such as Vestas and Gamesa, which despite being industrials, have also thrived. Good positive returns have still been available where growth trends have continued.

Our focus is on dealing with markets as we see them, rather than predicting how they might be in the future.

Our remit is capital preservation with modest real returns over time. In that sense we don’t have to try and predict how or when the market might turn as we don’t invest in indices, we invest in individual securities.

We just need to build a diverse portfolio of securities across the asset classes, which gives us a high probability of positive returns.

However, what is evident is that, as the areas of the market that are distressed fall, they shrink as a proportion of the indices and, therefore, have less impact.

Unless the economic weakness broadens out from resources and related areas into a more broad based recession, the indices will eventually improve as a consequence of mathematics if nothing else.

So a call on the indices is essentially a call on contagion.

Do the China and resources issues ultimately feed through to a more widespread recession or is this going to be a contained setback?

We are grateful not to have to make that call. Unlike index constrained managers, our job is to preserve capital and generate modest returns above inflation and there remain many areas available to us which offer that prospect.

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