The COVID -19 mayhem has caused tremendous uncertainty and volatility in equity markets. With no progressive signs of containing the virus, almost every sector bearing the brunt and livelihoods disrupted, in such tumultuous environment, where can investors turn to?

Here’s some good news…The defensive sector has emerged better than the rest.

What’s a defensive sector?

Defensive sector is a collective name given to industries that tend to generate stable profits throughout all phases of the economic cycle.

During difficult economic times, consumers typically reduce spending on non-discretionary items, such as entertainment, travel, and high-end clothing, and stick to buying only essentials, including food, health care, and basic utilities.

The companies that often deal with goods and services that are basic necessities are collectively called defensive sectors. Even during tougher times, consumers can barely afford to cut down spending on these goods and services. This is why they are relatively unmoved by the economy.

FMCG and Healthcare and Pharma companies are two main sectors of economy that are termed as defensives.

Characteristics of defensive sectors…

  • They are non-cyclical in nature and don’t go out of fashion.
  • They have a perennial demand
  • Large companies with stable business models
  • Focus only on the basics needs /essentials
  • Conservatively valued in terms of price to earnings and price to book ratios
  • Betas of such companies are sharply lower than 1 and are good beta bets during market downturns

Why investors prefer investing in Defensive sector?

The basic idea of investing in defensive sector funds is to protect (defend) against significant market corrections. If you buy funds invested in defensive industries, your holdings should, theoretically, decline less dramatically since the underlying stocks would fluctuate less in price during a decline.

Hence, when investors are worried about the state of India’s economy, they opt for defensive sector funds. This is because investors feel that these funds will be profitable even if the economy is not doing well. So, they are a safer bet than cyclical stocks.

Defensive sector funds remain relatively stable in price throughout the economic cycle; the trade-off is that these funds experience less dramatic growth during market upswings compared to higher-risk, cyclical industries.

How has the defensive sector performed in the last six months?

Currently, the FMCG Index and Healthcare and Pharma Index have performed better on a YTD basis as shown below in the graph.

Graph: Defensive sectors have outperformed the S&P BSE Sensex

Base taken as 10000
Data as on 20 July 2020
(Source: ACE MF, PersonalFN Research)

Since many leading pharma companies are conducting research and launching vaccines and medication to cure COVID-19 patients, there has been rally in S&P BSE Health Care Index.

Similarly, S&P BSE FMCG index was up for companies that are manufacturing essential goods like tea, coffee, toothpastes, toothbrushes, personal care products (soaps, shampoos, creams,) and hygiene and sanitation products are continuously being produced to keep up with demand in the ongoing crisis.

Hence even some of the top 5 FMCG sector funds and Pharma & healthcare funds have outperformed the benchmark indices.

Table 1: How have FMCG funds and Pharma & healthcare funds performed?

Scheme Name Absolute Returns CAGR
6 Months 9 Months 1 Year 3 Years 5 Years 7 Years
Healthcare and Pharma -sector
Nippon India Pharma Fund 26.88 40.48 39.05 14.89 7.80 16.22
UTI Healthcare Fund 24.79 41.90 39.16 9.42 2.82 11.86
SBI Healthcare Opp Fund 24.32 39.90 40.29 6.88 1.44 13.34
Aditya Birla SL Pharma & Healthcare Fund 18.91 30.43 30.69
DSP Healthcare Fund 25.48 45.05 45.38
FMCG -sector
Mirae Asset Great Consumer Fund -12.80 -5.51 1.07 6.33 9.89 16.00
ICICI Pru FMCG Fund -5.15 -3.23 3.01 5.71 9.21 10.86
SBI Magnum Comma Fund -5.97 1.40 2.07 1.36 8.35 12.46
Quant Consumption Fund 3.55 9.97 2.53 0.94 7.93 16.81
SBI Consumption Opp Fund -20.53 -16.69 -10.83 -1.26 6.14 8.23
S&P BSE Health Care – TRI 22.54 37.76 31.68 5.94 -0.18 9.73
NIFTY PHARMA – TRI 26.21 39.84 27.22 2.36 -3.81 6.07
S&P BSE 500 – TRI -11.30 -4.35 -5.23 2.29 5.90 11.14
NIFTY 200 – TRI -11.33 -4.86 -5.71 2.86 5.85 10.79
NIFTY COMMODITIES – TRI -15.28 -10.77 -15.13 -4.55 4.21 6.91
NIFTY FMCG – TRI 0.63 1.01 7.09 5.93 10.28 8.73
NIFTY CONSUMPTION – TRI -3.60 -1.47 7.51 4.45 7.55 11.04

Data as on 20 July 2020
(Source: ACE MF, PersonalFN Research)

Take a look at the risk ratios, which actually talks of the risk- adjusted returns that the top 5 funds of each category will provide, and their standard deviations to know the extent of volatility of the fund and Beta generated.

Higher the Sharpe Ratio, higher you are compensated for the risk the fund has taken and a higher Sortino ratio indicates better is the risk adjusted returns. As seen below both the ratios of each fund is low but has a high beta and standard deviation.

Table 2: Risk ratio trade-offs in terms of returns

Scheme Name Average Standard Deviation Beta (Correlation) Sharpe Sortino
Healthcare and Pharma -sector
Nippon India Pharma Fund 1.30 6.05 0.86 0.13 0.27
UTI Healthcare Fund 0.88 5.98 0.85 0.06 0.12
SBI Healthcare Opp Fund 0.69 6.23 0.87 0.02 0.04
Aditya Birla SL Pharma & Healthcare Fund 2.40 7.56 0.82 0.25 0.48
DSP Healthcare Fund 2.09 6.10 0.77 0.25 0.50
FMCG -sector
Mirae Asset Great Consumer Fund 0.78 6.00 1.03 0.04 0.06
ICICI Pru FMCG Fund 0.58 5.04 0.91 0.01 0.01
SBI Magnum Comma Fund 0.34 6.61 0.88 -0.03 -0.05
Quant Consumption Fund 0.24 6.28 0.98 -0.05 -0.07
SBI Consumption Opp Fund 0.19 6.28 1.01 -0.06 -0.08

Data as on 20 July 2020
(Source: ACE MF, PersonalFN Research)

Should you invest in Defensive sector fund now?

The worst might be already in the stock prices. Going forward, the slightest encouraging news may spark off massive rallies in their stock prices. These sectors are showing lower de-growth compared to others.

Most of India’s leading pharma companies reported an increase in revenue ranging from high-single to mid-double digits, benefitting from the growth in the US and European markets and continued momentum in the domestic market, during the fourth quarter of 2019-20.

While defensive sectors remain relatively stable in price throughout the economic cycle, the trade-off is that they experience less dramatic growth during market upswings compared to higher-risk, cyclical industries. The down side is they are prone to concentrated sector specific risk.

Hence, these funds are not for the faint hearted as it involves more risk as compared to the diversified funds. Invest only if you are willing to bear the risk and have an investment time horizon of 5 years or more. You may consider allocating some portion to it, only after due diligence of the fund based on its qualitative and quantitative parameters.

Read: How To Check If A Mutual Fund Scheme Is A Consistent Performer Or Not

But in terms of average category returns of the diversified funds is still better than the average defensive sector funds‘ returns. The portfolio traits of diversified funds have been more consistent and are largely driven by stock-specific activities in most cases, not just the sectoral trends … and hence more diversified.

Table 3: Category Average Returns

Category Name Absolute Returns (%) CAGR (%)
9 Months 1 Year 3 Years 5 Years 7 Years
Consumption -2.53 5.58 3.28 7.16 12.14
Pharma & Health Care 38.25 41.35 9.97 3.75 13.64
Large & Mid Cap -4.17 -0.64 1.44 6.15 14.00
Large Cap Fund -4.61 -1.16 3.23 5.80 11.80
Mid Cap Fund -0.93 2.42 0.35 5.23 16.26
Multi Cap Fund -4.35 -0.42 2.37 5.70 13.21
Small cap Fund -3.43 -2.69 -4.53 4.04 15.05
S&P BSE 500 – TRI -4.30 -1.93 2.69 6.09 11.29

Data as on 20 July 2020
(Source: ACE MF, PersonalFN Research)

These funds have a flexible investment mandate to invest in sectors that look promising; which are expected to do well in the medium to long-term. Diversified equity mutual funds go by broader macroeconomic trends and not necessarily one sector or theme. Thus, they tend to do well during economic and market upswings.

This article first appeared on PersonalFN here

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