Defensive funds safest to invest in

Stock market investors group companies into sectors to gauge their likely performance at different times in the economic cycle.

For example, producers of food and beverages and tobacco fall within consumer staples, a sector often called “defensive”.

According to global asset manager Schroders, this is because demand for food, cigarettes, etc, typically remains stable regardless of the performance of the wider economy. Therefore, revenues and profits for these kinds of companies tend to hold up well, even if the broader economy is suffering a downturn.

As a result, these defensive companies are often perceived as safe, reliable investments. Such companies can be of particular interest to income investors as their stable profits often allow them to pay consistent dividends.

By contrast, Schroders says that “cyclical” sectors are those that perform best when the economic times are good but they tend to see demand fall away when the economy slows.

“Autos and retailers are classic consumer cyclical sectors, because people spend more when they are confident about the economic outlook. Materials and industrial stocks fall into the same bracket as companies invest more when they expect demand to rise,” the company notes.

However, the revenues and profits, and therefore share prices, of these cyclical companies can be volatile as demand ebbs and flows alongside the performance of the broader economy. What does risk really mean? Schroders says that many investors make the error of equating this day-to-day share price volatility with risk. Risk, in investing terms, means the risk of permanently losing capital.

Substantial research points to the fact that the price you pay is the key determinant of the returns you make. The most critical risk, therefore, is the risk of overpaying for an investment in the first place. – Moneyweb