What is a Defensive Investment Strategy?
A defensive investment strategy is a conservative method of portfolio allocation and management aimed at minimizing the risk of losing principal.
A defensive investment strategy entails regular portfolio rebalancing to maintain an intended asset allocation. It also involves buying high-quality, short-maturity bonds and blue-chip stocks; diversifying across sectors and countries; placing stop loss orders; and holding cash and cash equivalents in down markets. Such strategies are meant to protect investors against significant losses from major market downturns.
- Defensive investment strategies are designed to deliver protection first and modest growth second.
- Many portfolio managers adopt defensive investment strategies for risk averse clients, such as retirees without steady salaries.
- Typical investments in a defensive strategy include high-quality short-term bonds (such as Treasury notes) and blue-chip or defensive stocks.
Understanding a Defensive Investment Strategy
Defensive investment strategies are designed to deliver protection first and modest growth second. With an offensive or aggressive investment strategy, by contrast, an investor tries to take advantage of a rising market by purchasing securities that are outperforming for a given level of risk and volatility.
An offensive strategy may also entail options trading and margin trading. Both offensive and defensive investment strategies require active management, so they may have higher investment fees and tax liabilities than a passively managed portfolio. A balanced investment strategy combines elements of both the defensive and offensive strategies.
Defensive Investment Strategy and Portfolio Management
A defensive investment strategy is one of several options in the practice of portfolio management. Portfolio management is both art and science; portfolio managers must make critical decisions for themselves or their clients, taking into account specific investment objectives and selecting proper asset allocation, balancing risk and potential reward.
Many portfolio managers adopt defensive investment strategies for risk averse clients, such as retirees without steady salaries. Defensive investment strategies could also be appropriate for those without much capital to lose. In both cases, the objectives are to protect existing capital and keep pace with inflation through modest growth.
Investments for a Defensive Investment Strategy
Selecting investments in high-quality short-maturity bonds, such as Treasury notes and blue-chip stocks are solid tactics for a defensive investment strategy. Even when picking stocks, a defensive portfolio manager will stick to large, established names with good track records. Today, that portfolio manager is more likely to lean towards exchange traded funds that mimic market indices, as these offer exposure to all the established stocks in one diversified investment.
A portfolio manager practicing a defensive strategy may also hold a moat of cash and cash equivalents, such as Treasury bills and commercial paper, which can help to keep pace with inflation and protect the portfolio in down markets. However, keeping too much in cash and cash equivalents may provoke questions as to why the investors are paying for active management in the first place.
Defensive stocks are shares that provide consistent dividends and stable earnings regardless of the state of the overall stock market. There is a constant demand for their products, so defensive stocks tend to be more stable during the various phases of the business cycle. Defensive stocks are also less likely to face bankruptcy because of their relative strength during downturns. On the other hand, the low volatility of defensive stocks often leads to smaller gains during bull markets and may lead to a cycle of mis-timing the market.