How to Build Defensive Equity Portfolios

Larry SwedroeTraditionally, risk-averse investors seeking defensive equity strategies have focused on low-volatility or low-beta assets. However, the objectives of defensive investors may go beyond volatility reduction to include long-term capital preservation, economic exposure diversification, and drawdown reduction. Given those considerations, a minimum-variance approach may not be the optimal portfolio.

Ross French and Niklas Gärtner contribute to the literature with their study, “In Search of a Defensive Equity Factor,” published in the April 2023 issue of The Journal of Portfolio Management, in which they sought to establish which equity factors are appropriate for defensive investors. They defined defensiveness along three dimensions:

  • Low risk of permanent capital loss – defined as a total return of -30% or less between each respective analysis date and the period ending December 31, 2021. In addition, to ensure that the stock characteristics at the time of analysis were relevant to the stock’s subsequent loss, they also required that the total return over the year following the analysis date was negative.
  • Low business cycle risk.
  • Low market risk – should have comparatively low variance, be less negatively skewed than the market, and avoid extreme returns.