With market volatility expected to continue in 2023, defensive investments have become an important component of a balanced portfolio. Defensive investments refer to assets that provide stable returns and reduce overall portfolio risk. This article will examine key strategies for defensive investing, including allocating more to bonds, holding cash, investing in defensive sectors, and utilizing alternative assets. Proper defensive allocation is crucial to preserve capital and smooth returns during periods of elevated market risk. By incorporating the right mix of defensive investments, investors can achieve true diversification and improve their risk-adjusted returns.
Increase allocation to investment grade bonds
Bonds, particularly high quality investment grade bonds, are a classic defensive investment. When stock markets decline, bond prices often rise as investors flee to safety. Investment grade corporate and government bonds provide steady coupon payments and predictable returns not tightly correlated to stocks. Conservative investors may consider overweighting their portfolio to bonds compared to their target allocation during times of market stress. This provides downside protection while still generating income. Shorter duration bonds also reduce interest rate sensitivity. Potential bond investments include short-term corporate bond funds, government bond ETFs, and high grade individual issues with maturities under 5 years.
Hold adequate cash reserves
Holding cash is one of the simplest defenses against market declines. Investors should evaluate their emergency fund, near-term spending needs, and cash buffer to withstand periods of volatility. While cash produces minimal returns, it provides liquidity and preserves capital when investors need it most. During major stock corrections, rebalancing into equities from cash can also take advantage of lower valuations. Conservative investors may hold 10-20% in cash as dry powder, while more aggressive investors can target 2-5%. Cash also provides funds for unexpected expenses and opportunities without selling assets at the wrong time.
Seek defensive equity sectors and dividends
While equities carry more risk than bonds or cash, certain stock market sectors provide more safety than others. Defensive sectors like healthcare, utilities, and consumer staples tend to hold up better in downturns given stable demand for their products and services. Investors can target defensive stocks using sector funds and ETFs. Dividend paying stocks can also provide equity income and cushion against volatility. Blue chip companies with long dividend growth records are a common defensive choice. Utility stocks, real estate investment trusts (REITs), and other high dividend payers give investors equity participation with lower volatility.
Incorporate alternative investments
Alternative assets like commodities, private equity, and hedge funds can enhance portfolio diversification during times of instability in traditional stocks and bonds. Gold and other precious metals often rise when fear drives investors to safety. Commodity funds provide exposure. Private equity and hedge funds utilizing strategies like arbitrage and short selling can produce uncorrelated returns. While alternatives come with specialized risks, they can offset weaknesses in conventional asset classes. Many alternatives also provide non-market driven returns by exploiting structural inefficiencies and illiquidity premiums. Used judiciously, alternatives improve a portfolio’s resilience.
Constructing a resilient portfolio goes beyond diversification into stocks and bonds. By proactively allocating to defensive investments like high quality bonds, cash reserves, low volatility equity sectors, and alternative assets, investors can balance risk and preserve capital during periods of elevated volatility and weak market returns. Maintaining defensive positions allows investors to remain invested for the long-term by smoothing volatility spikes and bear markets.