A little shelter from the storm
Searching healthcare and real estate for some defense
Defensive sectors have outperformed the main indexes substantially this year. So it makes sense to include these in your portfolio. But there’s often confusion about which sectors are actually “defensive.” Here’s a look at some that I think fill the bill.
While energy and materials have been the big beneficiaries of rise in commodity prices due the war in Ukraine and the associated sanctions, other less volatile sectors have also delivered outperformance. For example, utilities and financials have hkeld there own. The iShares S&P/TSX Capped Utilities Index ETF (TSX: XUT) is ahead 4.6% year to date, and the iShares S&P/TSX Capped Financials Index ETF (TSX: XFN) is down only 2.9%.
Two other defensive sectors that are not well represented in the Canadian index are healthcare and pharmaceuticals, which also benefit from the appreciation of the U.S. dollar. After the biggest global pandemic in a century and with the rapidly aging population of developed economies, it’s surprising that the performance of companies in these sectors hasn’t been better, especially as public attitudes towards big pharma have undergone a major change after their efforts to fight Covid-19.
The iShares Global Healthcare Index ETF (CAD-Hedged) (TSX: XHC) is down 4.9% year to date while the S&P 500 Composite Index is down 23%, the Nasdaq Composite Index has lost 31%, and the MSCI World Index has dropped 21% year to date. Within the universe of healthcare stocks, listed by market capitalization, Johnson & Johnson (NYSE: JNJ) is up 1.2% year to date, Eli Lilly and Co. (NYSE: LLY) has gained 7.6%, AbbVie Inc. (NYSE: ABBV) is ahead 6.0%, Merck & Co. (NYSE: MRK) is up 14.9%, AstraZeneca PLC (NSD: AZN) up 7.9%, and Bristol-Myers Squibb Co. (NYSE: BMY) is ahead 22.6%.
Some stocks in this sector are down year to date, like Pfizer Inc. (NYSE: PFE) (-18.5%), and Abbott Laboratories (NYSE: ABT) (-25.7), due to the falloff in Covid vaccine sales and the problems with infant formula production, in general healthcare companies have been performing well, and their dividend payments have been an added attraction both reducing volatility and providing yields in the 2%-5% range. Investors should use rebounds in former growth favourites, such as the the big tech stocks, to switch into stocks with excellent long-term fundamentals and selling at reasonable valuations in the healthcare sector.
Real estate investment trusts
Real estate might also be considered a defensive sector, especially REITs, which provide a steady income stream. Rising interest rates will undoubtedly dampen down the rapid increase in housing prices in Canada and the U.S. with the likelihood that 30 year mortgage rates over 5% will see prices flattening our by year-end. Nevertheless, property has some useful characteristics as an inflation hedge as an asset class that retains its value in real terms.
During periods such as the 1970s and 2000s, housing prices kept pace with inflation or even exceeded it, as interest rates that were negative in real terms reduced the real amount of mortgage borrowings and encouraged investors to seek protection from inflation in an asset they could buy with a lot of leverage.
Therefore it’s interesting to see the iShares S&P/TSX Capped REIT Index ETF (TSX: XRE) down 8.6% year to date and flat in price terms over the last five years. Of course, investors have received 3%-3.5% annually in income, so the average annual compounded rate of return is 7.4%.
Investors are worried that rising interest rates will negatively affect REITs, which carry a lot of debt, but almost all of that debt is fixed rate and secured against the assets of the trust. Both U.S. and Canadian REITs have refinanced at lower rates and reduced debt, so the larger worry is a possible recession, which would lead to vacancies due to tenants going bankrupt or walking away from their leases.
This was a much greater concern when Covid-19 first appeared two years ago, and the selloff was much larger, but the REIT market recovered once it became apparent that the damage was smaller than anticipated and confined to certain segments. The last time interest rates were rising in the U.S., from February 2016 to October 2018 when rates rose from 1% to 2.6%, the overall REIT market returned 22%.
Given that the increase in house prices has made buying a home less affordable and now with mortgage rates rising, renting has become more of an attractive proposition, especially as rental rates have generally risen in line with wage growth over the last few years. Apartment REITs have sold off more than the broader REIT index, which seems slightly odd given that the return to working from offices and the reopening of restaurants, shops, entertainment, and sporting facilities has reinforced the attractions of urban living.
The largest apartment REIT, Canadian Apartment Properties REIT (TSX: CAR.UN) is off 26% year to date. However, central urban specialist Minto Apartment REIT (TSX: MI.UN) is down 33%. However, Minto offers a pure play exposure to high-end apartments in central locations, with occupancy back over 94% and pays a 2.6% dividend yield.
Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management.
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Content © 2022 by Gavin Graham.
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