Time To Learn 'Defensive Investing'

David McEwen David McEwen is managing director of Investment Research Group

If investors want to make money in today’s investment markets, they need to learn the art of “defensive investing”.

This is a concept being promoted by US author Keith Fitz-Gerald, who defines defensive investing as paying careful attention to the risks you can tolerate - while still maintaining your upside.

“This begins with a cold, objective look at what mistakes you can afford to make. I talk to thousands of investors around the world each year, and I find that most have simply not asked themselves this question.

“On the other hand, if you have a clear understanding of your objectives, you can find ways to profit - even while investing defensively,” he says.

Fitz-Gerald is a believer in the concept that the more money central banks conjure out of thin air, the more problems are going to occur.

“It may take some time for the final meltdown to occur, but we've clearly entered an era in which world stock …cannot generate double-digit returns on a sustainable basis. I don't think many investors are set up for this financially or mentally.”

He advocates two strategies to manage volatility. First, create a simple portfolio structure with built-in safety brakes, such as protective stop-losses. Second, invest in "inverse funds" that are designed to move in an opposite direction of a market.
Various studies show that investing as little as 5% of your assets in such vehicles can remove 75% or more of a portfolio's overall volatility, while still preserving an attractive income stream.
Although he may be forecasting hard times, he stresses that such times offer a lot of opportunity and his longer-term viewpoint is optimistic.

I don't think it's a stretch to imagine the European contagion spreading. If the EU cannot hold things together, attention will shift in short order to the rest of the PIGS, then to the United Kingdom, and finally to America, which is little more than a pauper in Emperor's clothing at this point.

I think investing in real assets for the reasons I've just mentioned is a good start. So is the concept of buying sound currency.

History shows that both of these things tend to do well when governments are printing money out of thin air, as they seem to be doing right now.

Real assets figure to do well in the near term as a store of value - especially as central bankers degrade their own currencies by printing more and more of it. And in the long term - with great growth stories such as China and Southeast Asia setting the pace - the demand for such commodities will only grow. One area he feels will experience long-term gain is energy but he also likes gold and most resources.

Another defensive sector is the so-called "sin stocks” such as weapons, gambling, tobacco and alcohol.

Companies in these areas are thought to be insulated from economic slowdowns because most people don't view their "sins" as discretionary – in many cases they're addictions.

In reality, he says, sin shares can enjoy temporary insulation from economic conditions, but they do generally suffer when economic conditions impair consumers' ability to spend.

However, over the long term, sin shares perform well because consumers return quickly to their vices when the economy improves and spend aggressively during boom times.
Of course, companies that pay decent dividends can also be considered a defensive investment.

Dividend producers tend to be more stable than non-dividend paying companies and tend to outperform them in volatile markets. Dividends reinvestment plans, where available, also help investors substantially expand their holdings in down markets.