Slow and steady can win the race, as Aesop’s famous fable showed. The same can be said of equity investing. Experience tells us investors can secure superior returns over the long term by allocating capital to listed companies that have stable profitability, healthy balance sheets and trade at attractive valuations. Strangely, this is at odds with conventional wisdom.
Most investors tend to believe that gaining greater rewards requires taking on more risk. That's why they are often drawn to companies that promise rapid – and perhaps unsustainable – growth.The flipside to this behavioural bias that investors tend to underestimate the potential returns of stable, conservatively-run businesses.
Instead, we believe that investors can achieve superior returns by investing in a diversified portfolio of disciplined, conservatively-run companies bought at the right price.
Preserving capital during a market sell-off has a positive influence on long-term returns.
These businesses demonstrate an ability to generate attractive shareholder returns without taking undue risks. In our view, they are likely to be more resilient to changes in the business cycle and better prepared to face economic downturns.
Unearthing these companies demands comprehensive analysis. Our approach is to take a 360-degree view. We look at a number of business characteristics that combine to lend an equity investment a genuinely defensive profile. It's an approach that is different from many defensive equity strategies, which tend to focus on just one factor, such as stock volatility.
We also recognise, however, that there are times when certain types of defensive stocks trade at an excessive premium. This is why we constantly monitor and assess the valuation of individual defensive attributes and shift our investments accordingly. It's an approach that can deliver over the long run.
While defensive stocks tend to lag in the early stage of a market rally, they typically fall less, sometimes far less, than mainstream equity investments during a decline. Preserving capital during a market sell-off has a positive influence on long-term returns. Because of the compounding effect, the defensive stocks we invest in should outperform the MSCI World Index over the course of a market cycle, both in absolute terms and when adjusted for volatility. What is more, these stocks are more attractive than typical low-volatility stocks as they tend to fall less during a downturn and rise more in up markets.
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