Defensive Equity Investing : Appealing Theory , Disappointing Reality
نویسندگان
چکیده
Executive summary. Conventional wisdom maintains that investors can improve their portfolio's performance during bad times by shifting their equity exposure defensively toward less-cyclical, lower-beta sectors. This paper investigates the strengths and weaknesses of defensive equity investing by focusing on the historical performance of defensive sectors during two periods: U.S. equity bear markets and U.S. economic recessions. Using several high-level, intuitive leading indicators of recessions and bear markets, we simulate real-time defensive portfolio decisions from January 1963 through December 2006. We show that implementing a defensive investment strategy based on the leading signals of bear markets and recessions (e.g., forward price/earnings ratios, momentum indicators, and the shape of the U.S. Treasury yield curve) would not have resulted in better results than following a buy-and-hold strategy. The difficulties in converting historical patterns into real-time defensive portfolio outperformance include the low predictive power of even the best signals of bear markets and recessions, the strategies' potentially high transaction and tax costs, and the inconsistent performance of sectors over time. Indeed, equity market sectors once defined as " defensive " in the past do not always act defensively in the future (as was true with telecommunication services during the 2000–02 bear market). Moreover, defensive investing comes with a considerable and underappreciated cost—not being fully invested in the entire U.S. equity market when the bad times end.
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