Have defensive stocks lost their shine?

There are three things we need to get high conviction on.

One is an earnings surprise. Our view of a company's future earnings in the next one, two, three years has to be very different to the market's view. That's a key component of how we look at stocks.

The second one is high quality. We only invest in stocks we perceive to have high quality. And we're talking about financial metrics, balance sheets, the industry structure, the company's operations management, ESG. That also means we tend to lean into more mid-caps, large cap stocks. Rather than small caps.

And then the third one is valuation. We really try not to overpay for these earnings and high quality. And there it comes down to individual research and valuation approaches for each stock.

Do defensives still have a place in the portfolio?

We would say that defensives still have a spot to fill in a portfolio, just a smaller space. They need less space now. And the reason is just where we are in the cycle and how much these stocks, how much weight they've actually pulled in 2022.

A couple of these flagship defensives that we like, McDonald's outperformed the market by 30% last year, trading at 25 times forward earnings. It's well understood the business is doing well. A lot of investors are on board.

Pepsi, very similar, outperformed by 30%. Trading at a pretty high 25 times earnings.

And even in the healthcare sector, we have these defensive champions like Merck Pharma Company outperformed by 70% last year.

So it's clear that 2022 was one of those years where companies that win by not losing outperformed a lot. So they pulled a lot of weight. And it's not that these companies are doing badly now, it's just that the investment case is running out of a bit of steam.

So our conclusion is that there's still enough uncertainties in the world for defensives to defend a position in your portfolio. But having said that we think they should be a smaller part of the portfolio than last year.

If you stick to quality companies they have an ability to surprise you less when things are tough, when headwinds are there. And when things do go wrong, they self-heal, they can heal faster. And you tend to have much less permanent damage to your investments and your money if you stick to quality investments.

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As a specialist, active, core equities investment manager, Alphinity's aim is simple and effective: to identify opportunities across market cycles and invest in quality, undervalued companies with underestimated forward earnings expectations. Visit their fund profile or website to find out more. 

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