Choosing the right assets and instruments or other investment options is an integral part of a defensive investment strategy. These so-called defensive assets and instruments allow defensive investors to prioritize the protection of their capital or accumulated wealth from losses first. Generating gains via passive income, capital appreciation, or both comes second. What exactly are these defensive assets and instruments?
The 6 Types of Defensive Assets and Instruments
A key principle of an investment strategy that leans toward a defensive stance is to minimize or eliminate losses due to the volatility of the financial markets or during market downturns and overall economic slumps. A defensive investment strategy is both a risk management strategy and a wealth preservation strategy that primarily entails an active approach to portfolio management while also embracing some principles of passive investing for long-term capital preservation. The following are the different types of defensive assets and instruments:
1. Cash and Cash Equivalents
One of the most common types of defensive assets and instruments are money market products such as cash and cash equivalents such as Treasury bills and Treasury notes, as well as commercial papers. These assets and instruments have the advantage of being the most liquid among all other assets and instruments. They are also the most accessible.
Keeping cash and cash equivalents helps defensive investors maintain their liquidity and enable them to make purchases as quickly as possible. However, the downside to these assets and instruments is that they tend to fail at outpacing inflation. Note that keeping cash on hand or in bank accounts is the best way to lose to inflation.
2. High-Quality Bonds
Bonds are fixed-income securities and debt instruments. Institutions that issue bonds have debt obligations to their bondholders that involve paying yield and returning the principal upon maturity. Of course, bonds have risks. There are also different types of bonds. Defensive investors choose high-quality short-term and medium-term bonds.
Examples of defensive bonds include U.S. Treasury Bonds and U.S. Savings Bonds, high-grade municipal bonds, and high-rated corporate bonds. These bonds have a shorter duration with a maturity period of less than 5 to 6 years and they are issued by institutions with a strong financial position as determined by their high credit rating.
3. Defensive Stocks
Stocks are riskier than money market accounts and bonds. Investing in them is suitable for investors with an aggressive risk profile. However, there are different types of stocks and some of them can provide a safer haven for risk-averse investors. These are so-called defensive stocks and they tend to be stable during downturns and slumps.
Defensive stocks are issued by companies that provide in-demand goods and services. Examples include utility providers, healthcare-related companies, and consumer staples manufacturers. Some of these companies are also value stocks and mid-cap to large-cap stocks that provide steady dividends or demonstrate consistent and stable gains.
4. Defensive Pooled Funds
There are pooled funds such as mutual funds and exchange-traded funds that are designed for a defensive investment strategy. These funds are composed of several types of defensive assets and securities. An example is an actively managed balanced fund that is composed of equal portions of defensive stocks and defensive bonds.
Another example is a defensive sector fund that invests in defensive industries and sectors. Most actively-managed funds can also be defensive in nature. Fund managers adjust the composition of these funds depending on the business cycle of the economy. To be specific, during a recession, these funds invest in defensive sectors and industries.
5. Productive Real Estate
Real estate properties cannot be considered productive if they remain idle or unused. Maintaining these properties have costs such as real estate tax, association dues in certain areas, and other costs associated with upkeep. Note that another downside of real estate investing is its low liquidity. Investors cannot readily dispose them.
However, productive real estate can be part of a defensive investment portfolio because they deliver a stream of passive income. Prime examples include farmlands, all rental properties such as residential apartments and lands open for leasing. Commercial properties are also income-producing if rented out by commercial tenants.
6. Precious Metals
Investing in precious metals such as gold can be an effective part of a risk management and wealth preservation strategy. Note that gold is a defensive asset because it tends to hold its value well amidst market downturns and economic slumps. Other notable examples of precious metals include rhodium, iridium, silver, palladium, and platinum.
Precious metals can also provide investors with gains because their respective values tend to rise at or above the inflation rate. They are also tangible assets. They hold value beyond their investment purposes because they can be liquidated readily or used in other products. Gold and silver are used in jewelry while rhodium has several industrial applications.