When markets correct, it is a good time to revisit which equity market sectors are “defensive” themes. Certain products and services are nondiscretionary in nature that we cannot live without. This means that companies in these segments have greater market resilience and pricing power, independent of the macroeconomic environment.
Utilities, food and groceries, and health care are three traditionally defensive sectors. Let’s review the ETF landscape to make some defensive thematic selections in these categories and a few more.
Utilities
As I wrote about last week in an article entitled “Where’s the Juice,” utilities – particularly unregulated utilities – have performed well this year. However, in a more defensive environment, a more diversified portfolio of utility stocks with lower beta exposure to the overall market may be preferable. The SPDR Utilities Select Sector Fund (XLU) has the lowest correlation with the S&P 500 Index, with a one-year correlation of 0.328, and the Vanguard Utilities ETF (VPU) also has a low correlation of 0.338. (A perfect correlation is 1.00). Both those funds have not been immune to the recent bout of profit-taking but have held up much better than the overall market, and both pay dividends as well. XLU pays an annual dividend yield of 2.96% and VPU’s dividend yield of 3.02%, which investors receive quarterly.
Food and Groceries
Food and groceries both fall under the consumer staples sector. Even though Consumer Staples ETFs also include more discretionary categories such as tobacco, beverages, and grocery store retail, they are still a good way to get this defensive exposure. Here we have the SPDR Consumer Staples Select Sector Fund (XLP), the Vanguard Consumer Staples ETF (VDC), the iShares Consumer Staples ETF (IYK), and the Fidelity MSCI Consumer Staples ETF (FSTA). Again, all these funds have low correlations to the broad market, with an average one-year correlation of only 0.404, but IYK has the lowest correlation to the S&P 500 Index – only 0.326. All these funds also pay nice dividend yields, with IYK paying a handsome 4.36% annual dividend yield.
Health Care
Health Care ETFs are a broad category that includes broad healthcare, healthcare services, pharmaceuticals, biotech, and medical devices. The defensive thesis is that regardless of what is going on with the macroeconomy, consumers still need to fill their prescriptions and get medical procedures. Thanks to mandated health insurance, most people have insurance coverage whether they are employed or not, making it less economically sensitive. That said, botox injections are more discretionary than kidney dialysis, and biotechnology research is very capital intensive, making it more interest-rate sensitive.
Several pharma-focused ETFs exist, including the VanEck Pharmaceutical ETF (PPH), the Invesco Pharmaceuticals ETF (PJP), and the iShares U.S. Pharmaceuticals ETF (IHE). Several broad-themed healthcare ETFs exist, including the SPDR Health Care Select Sector ETF (XLV) and the iShares U.S. Healthcare ETF (IYH). Health care has a low correlation with technology exposure (0.27), providing a nice diversification benefit as most portfolios these days are overweight the tech sector.
