What Are Defensive Sector Funds?

How to Get Defensive With Sector Funds

Man in a suit in a field with a sword and shield
••• Getty Images

When the economy is getting weaker, many investors begin to pad their portfolios with defensive sector funds. Because these funds can perform better than the broader market during recession or a bear market, they are referred to as "defensive." Examples of defensive sectors include healthcare and consumer staples.

What Are Defensive Sector Funds?

Defensive sector funds are mutual funds or exchange-traded funds (ETFs) that primarily or exclusively invest in defensive sectors. Sector funds focus on a specific industry, social objective or industrial sectors such as healthcare, real estate or technology. Their investment objective is to provide concentrated exposure to specific industry groups, called sectors.

The basic idea of defensive investing is to protect (defend) against significant declines in share prices that are associated with market corrections. For example, during difficult economic times, consumers typically reduce spending on luxury items, such as entertainment, travel and high-end clothing, and buy only what they need, such as food, healthcare, and basic utilities.

Four Examples of Defensive Sectors

Here are the primary sectors considered to be defensive stock:

  1. Consumer Staples Sector: Consumer staples, also known as consumer non-cyclical stocks, are considered defensive because they tend to maintain more price stability in a down market than other stocks, such as growth stocks or consumer cyclical stocks. For example, during a recessionary period, consumers still need staples, such as cereal and milk, or they may even increase the consumption of so-called "sin stock" products, such as cigarettes and alcohol. Knowing this, many investors will buy defensive stocks when they believe a recession is likely to occur in the short-term.
  2. Healthcare Sector: This is a broad defensive sector. Even a person with no investing experience can think of some specific area of the health industry, such as hospital conglomerates, institutional services, insurance companies, drug manufacturers, biomedical companies, or medical instrument makers. Examples include Pfizer, UnitedHealthcare, Cigna Corp, Abbott Laboratories, and HCA Holdings, Inc. These are companies that offer products or services that consumers may continue to buy in difficult economic times because health is a high priority and people still need to go to the doctor and buy medications in hard times. This is why health is a defensive sector.
  3. Utilities Sector: You are already familiar with utilities in your day-to-day life and likely associate the term with your "utility bills." Utilities stocks are considered defensive because, during a recessionary period, consumers still need utility services, such as gas, phone and electric. Knowing this, many investors will buy defensive stocks when they believe a recession is likely to occur in the short-term.
  4. Commodities Sector: Commodities are better categorized as assets, rather than industrial sectors but they can serve a similar purpose as defensive stock sectors. Commodity goods examples include crude oil, coal, corn, tea, rice, gold, and silver. Not all of these basic goods are defensive by definition but they still have the potential for maintaining price stability during recessionary environments. For example, gold can rise in price in economic downturns because investors perceive it as a "safe" alternative to stocks or currencies during such uncertain environments.

Bottom Line

Keep in mind that defensive sector funds can still lose value, even though they may perform better than the broad market in bear markets. For this reason, sector funds can be wisely used as diversification tools by allocating small percentages to them. Defensive sector funds can be one part of a broadly diversified portfolio of mutual funds.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.