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How to Invest Defensively: Part 2

“Rule number one: Never lose money. Rule number two: Never forget rule number one.” Superinvestor Warren Buffett lives by that advice, and it seems to have worked out well for him. Investing defensively, as Buffett does, is easier said than done, but the right strategies can certainly help you avoid losing money. In the second part of this series, we’ll talk about which sector of the market tends to harbor the stocks friendliest to defensive investing.

Defensive stocks are also known as “non-cyclical stocks;” their performance tends to be steady and uncorrelated to the general market condition. And if you’re looking for stocks that tend to keep making modest but steady money in every kind of economy, I suggest you start with utilities. After all, whether the economy’s booming or crashing, we all need heat, light, and water. You might cut back on shopping sprees, movie screenings, or nights out, but you won’t skimp on your utility bills.

Utilities in Hong Kong include CLP(SEHK: 2.HK), HK & China Gas(SEHK: 3.HK), and HK Electric Investments(SEHK: 2638.HK), to name a few. Their beta is currently around 0.3, which means that if the general market drops by 1%, these stocks would drop by 0.3%, assuming all other things remain constant.

We’ve talked about the demand-side factors that make utility stocks less volatile and more defensive. But the supply side matters, too. Utilities generally enjoy a monopoly status, with no rival suppliers to whom customers can switch. For example, CLP is the sole electricity supplier for Kowloon and New Territories; if you live or conduct business there, and you require electricity on a daily basis, you need to be a CLP customer. The same applies to HK Electric on the Hong Kong Island side.

When the stock market becomes volatile, utility stocks make an excellent defensive option to hedge against market volatility. Just remember that in a bull market, these stocks probably won’t enjoy the same soaring returns as high-beta stocks like technology stocks. So while defensive stocks like these make an excellent component of a diverse portfolio, you shouldn’t focus on them exclusively, unless you’re comfortable with slower, smaller returns.

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Disclosure: Johnny Chan does not own shares of any companies mentioned. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.