It is a myth that classic defensive sectors are too expensive, according to FE Alpha Manager Bill Mott, who says he has no plans to abandon his cautious strategy in the face of growing market optimism.

Former Credit Suisse Income star Mott, who now manages the PSigma Income fund, thinks it would be absurd to turn against defensive stocks at this stage. 

"Our view is that there is still more to come from selective defensives and we are sticking with our positioning, with some tweaks," he said. 

Defensive equities, which saw valuations rocket during the eurozone crisis, have been widely tipped for a fall in recent weeks. 

In a recent FE Trustnet article, Cazenove’s head of multi-manager Marcus Brookes said that defensives are now too risky as a slight blip in the market could cause valuations to drop drastically.

"We are trying to get away from traditional stocks for income and move into some cyclical areas of the market where, because there has been a rush for defensives, they are relatively cheap," Brookes told FE Trustnet.  

He added: "Cyclicals have priced in a tough backdrop already. However, if you see some slight problems in the defensives now then the share price premium they are on will start to become a problem." 

Mott disagrees. He believes it is ridiculous these stocks are not being viewed as safe and profitable investments.  

"We believe that in the current economic environment of low growth, companies that have a high dependability of earnings, because they sell everyday essentials, will be re-rated." 

"This process is underway, but as growth expectations continue to be downgraded, we believe that it has further to go."

"This is one of our central themes: 'dependability is undervalued'." 

Mott believes that these defensive stocks should be the first port of call for equity income investors as they can deliver sustainable dividends that will continue to grow. 

"We think that the income characteristics remain attractive. For example, Unilever has a dividend yield of 3.3 per cent, more than twice that of UK 10-year gilts." 

"We also think it is inconceivable that the dividends from companies like Unilever are going to do anything but grow – unlike your gilt coupon." 

According to FE Analytics, Mott’s PSigma Income fund includes defensives such as Vodafone, GlaxoSmithKline and AstraZeneca among its top-10. 

Since the fund’s launch in April 2007, it has underperformed against the IMA UK Equity Income sector and the FTSE All Share. The fund has lost 6.29 per cent while the index and sector have returned 11.05 per cent and 4.30 per cent, respectively. 

Performance of fund vs sector and index since April 2007

 

Source: FE Analytics

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However, the £395.5m portfolio concentrates on income over capital returns and its yield of 4.44 per cent is higher than the sector average. 

Other high profile equity income managers including Neil Woodford, Adrian Frost and Adrian Gosden share Mott’s cautious stance.

The Invesco Perpetual High Income and Artemis High Income funds are both heavily exposed to defensive stocks. 

Rob Morgan, investment analyst at Hargreaves Lansdown, thinks that only time will tell if this approach will pay off, but Mott has called the forecast correctly before.

Whether investors will be satisfied with his caution if they miss out on a rally is another matter, he adds.

"His defensive positions could underperform in a rally, but then he has been right on many of the macro-economic scenarios. However, he hasn’t converted his prognosis into performance as much as he would have liked."

"We are in a low growth world which is difficult as interest rates are low; so large defensives that give decent dividends look relatively attractive."

"However, it only takes a market rally like we have seen recently for funds like his to underperform."

Morgan believes that this continued market volatility and uncertainty means that the best way to profit in the current environment is through an equal blend of defensives and cyclicals.

"We haven’t taken a firm view, we think investors should look to blend both types; so when one doesn’t do well, the other does."

"If you have a good manager on either side of the argument in your portfolio then you will ultimately be adding to your chances of success," he finished.