Mind the Defensive Equities Gap in Portfolios

Opportunities

• Steady, Reliable Growth: Consumer staples benefit from persistent consumer needs, delivering a 5% CAGR over 60+ years with a low beta of 0.56, while healthcare spending has grown at an 8.6% CAGR with a beta of 0.86 — both providing growth with significantly less volatility than the market.

• Downside Protection: During market drawdowns, both consumer staples and healthcare sectors typically decline less than half as much as the broader market, providing crucial portfolio protection when markets face turbulence.

• Economic Moats: Quality defensive companies possess sustainable competitive advantages including strong brands (e.g., Coca-Cola), scale advantages (e.g., Procter & Gamble operating across hundreds of countries), favourable industry structure (concentrated sectors with oligopolistic characteristics), and intellectual property (particularly in healthcare companies).

Risks & Areas of Concern

• Short-Term Underperformance: Defensive sectors typically underperform during strong bull markets or when technology is in favour, as evidenced by their relatively weaker performance over the past few years compared to tech stocks.

• Quality Dispersion: Not all defensive companies are created equal—the performance gap between high-quality companies (e.g., Procter & Gamble) and lower-quality companies (e.g., Kellogg's with limited scale and power) can be substantial, with the former delivering 6% EPS growth versus 1.5% for the latter.

• Disruption Threats: Certain consumer staples face challenges from changing consumer preferences (e.g., cereal consumption declining – Kellogg’s) or e-commerce disruption, requiring continual adaptation and innovation.

• GLP-1 Impact: Weight loss drugs like GLP-1s may impact consumption patterns for certain consumer goods companies, particularly those selling unhealthy or indulgent food products.

• Regulatory Risk: Healthcare companies in particular face ongoing regulatory risks that could impact profitability and growth.

Portfolio Implications

• Adding 20% to the Magellan Global Fund to a typical index overseas equity portfolio would:

  • Shift the portfolios profile towards Mega Cap stocks (increasing allocating by 3%), while reducing exposure to Large Cap, Mid Cap, and Small Cap segments. This implementation increases concentration in the world's largest companies, particularly the Magnificent 7, increasing the overall exposure from 21% to 22% (of the international equity allocation). Although this change in exposure is slight, the allocation represents a greater concentration in the tech heavy mega-cap companies, driving global (particularly U.S.) index returns.

  • Concurrently, the Magellan Global Fund also provides the portfolio with greater exposure to 'defensive equities' through an increase in exposures to Consumer Discretionary, Staples and Healthcare sectors by 1-2% (of the international equity allocation). This positioning, particularly alongside reduced cyclical exposure in Financials and Materials, can insulate the portfolio by provide downside protection during market volatility while still capturing upside through quality growth companies.

  • According to consensus estimates, there will be an elevation in the Price-to-Earnings multiple (form 18x to 19x) and a slight increase in the long-term projected EPS growth.

• If you would like us to calculate conduct similar analysis for your model, SMA or client's portfolio please contact us below.
  

Economic Scenario Expectations

• Continued Economic Growth

  Quality defensive companies should continue delivering solid returns, though likely underperforming high-growth tech in strong bull markets.

• Mild Recession

  Defensive equities would likely outperform the broader market, particularly quality companies with strong economic moats. Companies with premiumisation strategies (such as Nestlé) would prove resilient as consumers can trade down within their brand ecosystems rather than abandoning them.

• High Inflation & Rising Rates

  Quality consumer staples and healthcare companies with strong pricing power would be well-positioned to pass inflation through to customers. Companies investing in R&D and brand strength (e.g., Colgate's increasing R&D investment) would maintain their competitive positions despite inflationary pressures.

• Severe Economic Downturn

  Defensive equities would likely outperform the broader market. Whereby companies with strong balance sheets, entrenched market positions, and essential products or services could provide crucial protection and potentially emerge stronger as weaker competitors falter.

Conclusion

Defensive equities could offer a compelling "free lunch" in portfolio construction— providing portfolios with greater downturn protection and although likely to underperform in bullish markets, has historically delivered market-beating returns with lower risk. Investors should mind the defensive gap in their portfolios, particularly given the tech sector's current stretched valuations and dominance in global indices.

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