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Is defensive investment the best attack?

Posted on 13. déc, 2011 by Riskelia in Weekly Focus | Commentaires fermés

As most investors focus on high profile and volatile assets such as geographical benchmark equities, commodities and high yield, all our indicators point towards defensive investments:

• Inflation bonds
• Emerging bonds
• Gold
• Defensive equities (low beta) such as consumer staples and health care sectors

Among the Radar’s 30 top positive bets, six belong to a ‘defensive category’, which can be defined as neither fully connected to safe haven bonds (i.e. US, UK bonds…), nor cyclical assets. These bets, all having recommendations over 30%, are detailed in figure 1. Contrary to safe havens, they offer some good protection against inflation, while behaving better than geographical benchmark equities in periods of financial turbulence.

The dual behavior of inflation and emerging bonds is illustrated in figures 2 and 3. The correlation to commodities is positive for instance whereas the dependence to equities and safe havens is variable over time. These hybrid assets fit well to the current context of negative real interest rates as they can perform well in stagflation or moderate growth environments.

We can build a portfolio consisting of inflation indexed-bonds, emerging bonds, gold and defensive stocks. For example, the following passive allocation is possible:

The currencies are either the dollar or the euro for European sectors. The currency effect may either be passively hedged or actively managed. Note that the current positioning of the Radar is strongly positive on the dollar.

This allocation offers significant upside performance while providing a protection in case of wild deleveraging. Riskelia’s Radar can enhance the portfolio’s properties by replicating a call on each individual asset inside the portfolio. The Sharpe ratio is just a little better but the maximum drawdown is reduced to a very acceptable loss for the investor. The active construction uses some common sense constraints: no leverage, maximum investments are respectively 100% to bonds, 20%to gold and 75% to defensive stocks. Cash is the non-invested part of the active portfolio.

The present allocation of the active portfolio is as follows:

As showed in figure 4 representing the active and passive performances over time, the current crisis looks pale in comparison to the 2008 meltdown as the whole portfolio is much steadier than it used to be in 2008 where all assets prices collapsed like a single man.

Figure 1: Top positive bets among defensive assets

Figure 2: Rolling correlation of worldwide inflation bonds with major assets (Equities, Commodities, Bonds)

Figure 3: Rolling correlation of emerging bonds major assets (Equities, Commodities, Bonds)

Figure 4: Passive and Riskelia’s active portfolios

Tags: Acceptable Loss, Commodities, Consumer Staples, Correlation, Defensive Stocks, European Sectors, Growth Environments, Health Care Sectors, High Profile, High Yield, Indicators Point, Inflation Indexed Bonds, Maximum Drawdown, Moderate Growth, Safe Haven, Safe Havens, Sharpe Ratio, Stagflation, Turbulence