Defensive ETFs for effective, low-cost diversification

Defensive ETFs for effective, low-cost diversification

Finding bear repellent in healthcare and consumer staples


The markets are taking a hit, with most of the big indexes having dropped into bear market territory, and recession talk is growing. There’s a saying on Wall Street that a rising tide raises all boats. The corollary is that an ebb tide does the opposite.

No matter how defensive your stock portfolio, you’re likely to see your net worth decline during a market correction. There are occasionally one or two sectors that resist the trend – this time it’s energy. But generally, when the broad market drops, it sucks down everything with it. Think of it as a financial black hole.

That said, historically some sectors are hit harder than others when the bear comes calling. During the crash of 2007-09, the MSCI World Sector Index dropped 41.23%. But financials and real estate did much worse, losing 58.5% and 54.5% respectively. Meanwhile, consumer staples and healthcare were down -22.44% and -24.95% respectively. Big losses, yes. But less than half that of financials and real estate.

Fast forward to the pandemic bear market of 2020. The MSCI World Index fell 20.1%, but energy (-43%) and financials (-30.16%) fared much worse. The least affected? Again, healthcare (-10.87%) and consumer staples (-12.06%).

Over the years, I’ve often recommended utilities and telecoms as key elements in creating a low-risk portfolio. I still like those sectors. But a sound defensive portfolio needs more diversification. The bear market performance numbers suggest that both healthcare and consumer staples should be added to the list.

ETFs offer low-cost diversification

The easiest way to achieve this is with exchange-traded funds (ETFs). They’re inexpensive and offer broad diversification, within the limits of their mandates. Here are two that are recommendations of The Income Investor newsletter. Results are as of May 27.

Harvest Healthcare Leaders Income ETF (TSX: HHL.U)
Type: Exchange-traded fund
Current price: $8.52 (figures in U.S. dollars)
Annual payout: $0.6996
Yield: 7.9%
Risk: Moderate

This ETF invests in an equally-balanced portfolio of 20 leading health service companies, including insurers, equipment manufacturers, biotechnology, and pharmaceutical companies. It’s an international fund, although most of the holdings are U.S. companies. Pharmaceuticals account for 40.3% of the portfolio.

Some of the top names include Merck & Co., Thermo Fisher Scientific, AstraZeneca, Eli Lilly, and Bristol-Meyers Squibb. All are large-cap companies (minimum capitalization is $5 billion). The managers write covered call options on a portion of the holdings to generate additional cash flow.

There are three investment options: HHL.U is denominated in U.S. dollars; HHL is hedged back into Canadian dollars and priced in loonies; HHL.B is also priced in Canadian dollars but is unhedged. We track HHL.U.

The fund has traded in a narrow range between $7.85 and $9.35 over the past year. It’s now at about the mid-point of that range, at $8.50.

One of the attractions of this ETF is the consistency of its distributions. They have been maintained at $0.0583 per month since the original fund (HHL) was launched in November 2014. Assuming that rate continues, the forward yield is 7.9%.

The performance record is very encouraging for defensive portfolios. The U units have never lost money over a calendar year since they were launched in 2017. The average annual compound rate of return (to June 30) since inception in Feb. 2017 is 10%.

Moving over to the consumer staples sector, I looked at both Canadian and U.S. entries using two main criteria: safety and cash flow. Here’s my choice:

BMO Global Consumer Staples Hedged to CAD Index ETF (TSX: STPL)
Type: Exchange-traded fund
Current price: $24.40
Annual payout: $0.56
Yield: 2.3%
Risk: Moderate

The fund was launched in April 2017 and has an average annual compound rate of return (to June 30) since inception of 6.3%. It took a hit in the market selloff in May, losing about 5.5% of its value in a three-week period, but that was a better result than the broad indexes.

The portfolio consists of 156 mid- to large-cap global companies. Top holdings include Procter & Gamble, Nestle, Coca-Cola, PepsiCo, and Philip Morris International. About two thirds of the stocks are U.S. companies, with 12% in the U.K. and the rest scattered around. Canadian representation is 1.09%.

Distributions are paid quarterly and are currently set at $0.14 per unit. If that rate is maintained (no guarantee), it would work out to $0.56 per year for a yield of 2.3% based on the current price. The MER is 0.4%.

To sum up, the yield is modest, but this ETF will add a degree of stability to the equity portion of an income portfolio.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

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Notes and Disclaimer

Content © 2022 by Gordon Pape Enterprises. All rights reserved. Reprinted with permission. The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.