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Set up a defensive portfolio to minimise risk

reduce risk

A defensive investment strategy is one that aims to preserve capital regardless of market conditions. As media and other commentators focus on uncertainty created by macro risks, we believe investors should consider strategies that actively focus on capital preservation and still deliver strong risk-adjusted returns.
A key tactic is to focus on less volatile “defensive” or “economically insensitive” industries. While no security is a sure thing, risk can be minimised by selecting companies whose key drivers are insensitive to the economic cycle.

At Pengana, we call these “toilet paper and toothpaste” companies, as no matter what the conditions people will still buy these staples. So their earnings are easier to forecast and value. Examples include healthcare, utilities, telecommunications and even gaming stocks.

Holding cash is another tactic many investors underestimate or misunderstand. Many feel holding cash is standing on the sidelines – but our view is that “if we don’t know, then we don’t play”. This allows us to focus resources where we can most likely achieve the “alignment of the planets” needed to maximise potential returns and minimise risks. Being able to hold cash also means we don’t have to buy if we can’t find stocks that pass our hurdles. Having cash in our wallet over the heady first half of 2015 allowed us to reach for it to buy stocks at great prices when the markets fell in August and September.

Overall, defensive investors need to be disciplined and take a pragmatic view of risk. Many investors, such as self-managed super funds, hold a fairly concentrated portfolio of direct Australian equities so every stock pick is critical. By focusing on our core objectives – a fair return and preserving capital – we can identify and react to the major relevant risks. We also consistently minimise risk by being disciplined in what we buy: investments that offer predictable, sustainable and well-stewarded after-tax cash earnings yields in excess of 6%, which will hopefully grow to double-digit yield levels over time.

Toilet paper and toothpaste stocks may not be sexy but slow and steady generally wins the long-term investment race by avoiding the worst market falls.

Rhett Kessler, Pengana Australian Equities Fund

Written by Rhett Kessler

Rhett Kessler

Rhett Kessler is senior fund manager with Pengana Australian Equities Fund.

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