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Is now the time to start getting defensive? Like most market-based investing questions, there never really is a definitive answer. Only hindsight will reveal the best time to invest in defensive stocks and defensive sector funds.
But when considering the current environment of record highs on the major market indices, above-average valuations and a Federal Reserve Board ready to start raising interest rates, now is as good a time as any to build some defensive padding into your portfolio.
Also, before looking for the best defensive sector funds to buy now, keep in mind an important point: Getting defensive doesn’t mean you’ll miss any strength remaining in a bull market. Nor does it mean you’ll see gains while everything else is tanking in a bear market correction.
What defensive investing can do is enable you to participate in at least some of the bull’s gains but minimize the downside of the bear’s declines.
So with the backdrop of trying to capture gains on the upside but still minimize losses on the downside, here are some outstanding defensive sector funds to consider adding to your portfolio:
Vanguard Health Care Fund Investor Shares (VGHCX)
Some investors may argue that the incredible gains in recent months and years in the health sector are due for a correction, and that the conventional wisdom about the sector’s defensive qualities may not hold true in the next downturn.
In some ways this argument holds water. But it’s the biotechnology sub-sector of health care that is likely the hot spot that deserves the caution. Therefore, a great way to capture the momentum that still remains in health care stocks – without getting too much exposure to overbought biotechnology stocks – is with a solid, well-managed, low-cost fund like Vanguard Health Care.
The fund has a rock bottom expense ratio of 0.34% and a track record of above-average returns. Top holdings, such as Bristol-Myers Squibb (NYSE: BMY) and Actavis PLC (NYSE: ACT), are the type of health sector stocks that have defensive qualities which can potentially hold up in a market correction.
Fidelity Select Consumer Staples Portfolio (FDFAX)
The fundamental idea behind defensive investing is to hold stocks in companies that sell products or services that consumers will keep buying even when money is tight, or the kind that investors will keep holding when sentiment is turning negative.
This is how funds like Fidelity Select Consumer Staples invest. It demonstrates how an actively-managed mutual fund can be a better idea than a passively-managed ETF in certain situations. The fund beat 99% of all consumer defensive stock funds for a 10-year annualized return of 11.2%.
The fund manager, Robert A. Lee, has been at the helm since June 2004, which means he receives full credit for the category-shattering 10-year performance. And for outstanding management like this, it’s tough to beat the 0.77% expense ratio.
Utilities Select Sector SPDR ETF (NYSEArca: XLU)
The utilities sector has taken a big hit in 2015, primarily because of the fear of higher interest rates. Utilities and other dividend-paying shares tend to compete with bonds as investments. Therefore, gaining exposure to the utilities sector now is a bit of a contrarian call, but the defensive qualities of utilities stocks shouldn’t be ignored.
A big positive for the utilities sector is that there is basically no viable substitute for its services. Consumers still need phone, energy and electric services in economic downturns. A great way to buy into the utilities sector is with a passively-managed exchange-traded fund like Utilities Select Sector SPDR. You’ll get broad exposure to the sector with a cheap expense ratio of 0.15%.
If you are considering adding defensive stock funds to your portfolio, a good idea can be to buy two or three but keep the total exposure minimal, such as 5% to 10% for each position. This way, you’ll add diversity to your portfolio without concentrating too much in one particular sector.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.
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