1. Fidelity Adv Consumer Staples I FDIGX

2. FBR Gas Utility Fund GASFX

3. MFS Utilities I MMUIX

4. Franklin Utilities A FRUAX

5. Rydex Consumer Products RYCIX

“Wall Street hates uncertainty” goes the old saying. Well, there is uncertainty aplenty in the markets these days. With turmoil in the Middle East, rising commodities prices, ongoing economic weakness in most major markets and a host of other variables, investors have to be prepared to deal with a higher than average dose of uncertainty. What is the best strategy for dealing with the various risks that might wreak havoc on portfolios? You’ll get different answers from different people, depending on one’s individual point of view. The problem with uncertain times is that it is much harder to be confident about a particular market view. You may think stocks are poised for large gains – and there is plenty of evidence to support that view – but it would not take much for things to go terribly wrong.

One phrase that often comes up in discussion during times like these is “defensive”. There are different ways to define defensive stocks, but the general principle is that they operate in industry sectors that have certain inherently predictable characteristics relative to other sectors – predictable in that the timing and magnitude of their cash flows is more or less dependable regardless of external economic conditions. “Defensive” stocks are usually contrasted to “cyclical” stocks, which tend to offer more attractive returns in economic good times, but can be very vulnerable during downturns.

Michael Stewart

Meet this week’s Jem5 investor, Michael Stewart. Michael works for a nonprofit organization in Washington DC where he is a policy analyst. 50 years old and married with a child currently in university, Michael is an enthusiastic investor but also tends to be cautious in his outlook on life. Because of his work Michael is very plugged into world events, and he is usually up to date on the latest foreign policy happenings or political goings-on.

Although he hears a lot of talk about the nascent economic recovery in the US and knows the stock market has been on a bull run for the last 18 months or so, Michael is not all that optimistic about the coming 1-2 years. He knows there is political gridlock in Washington, foreign crises and uprisings that could spill over into economic consequences, and households with stagnant incomes, high levels of debt and employment uncertainty. Michael decides he needs to research defensive stocks for his portfolio – where the gains may underperform the broader market but which will probably help him sleep better at night. He goes to Jemstep and narrows his focus to three industry sectors known to be particularly good for defensive positions: staple consumer goods, utilities and health care. Here are the results of the top 5 funds:

Jemscore: Michael gets a distribution of defensive sectors in his Jem5 query. One of the first things that is apparent is that defensive stocks are not “sexy”. You don’t see the overall Jemscores of 70 or higher that tend to show up in the top ranks of other profiles. That is understandable – these are not intended to  outperform the market as much as they are intended to offer fewer surprises if the economy turns on a dime. In fact, the reason why these Jem5 stocks are clustered so closely to the index benchmark in the overall Jemscore has less to do with their 3, 5 and 10 year performances (shown here) than they do with their performances within the last twelve months (which generally have been below average during an extended bull run – these can be viewed on the Jemstep ranked funds functionality).

In fact, the five and ten year numbers show Michael why these are probably the types of additions he needs for his portfolio – returns in the mid-high single digits and low volatility (mostly less than 20%) during the roller coaster ride this period has seen in the broader market. The fee structures for defensive funds also tend to be attractive – these are funds that by and large see less turnover and fewer complex active management decisions than other areas, so the fees tend to be commensurately lower.

In the end Michael decides to add two new funds to his portfolio. He goes with Fidelity Consumer Staples and Franklin Utilities. The latter, despite ranking below two other utilities funds, has a lower standard deviation, which appeals to Michael, good enough returns over the long term and is not concentrated in a small subsector (like FBR Gas). He feels this is the right decision for the uncertain times seen in the world today.

*Note: Jem 5 is a regular feature on the Jemstep blog which represents our top mutual fund ratings for unique investor profiles. For more information, read our first post in the series.

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