What’s in – defensive or cyclical stocks?

Should you now bet on defensive sectors or go for the cyclical ones? For equity investors and observers of market, the investment style of mutual funds is one way to know the market favourite segments. At a macro level, the universe of sectors can be divided into defensives and cyclicals. Sectors that are expected to be more resilient to downturns such as FMCG or IT or those that offer good dividend yield including oil marketing stocks fall in the defensive category.

Other old economy sectors such as cement, chemicals, banks, capital goods or construction can be classified under cyclicals. They are classified so, as they move in tandem with the economic growth or downturn or economic policies such as interest rates.

The market turbulence in the last two years ensured that defensive bets ruled the markets, with valuations of stocks in these sectors scaling up sharply, making them expensive.

But in 2012, the deployment pattern of mutual funds appears to suggest that cyclical stocks are in, albeit in a gradual sort of way. Exposure of mutual funds to stocks in the banking space, for instance, increased to 17.6 per cent in August 2012 from 15.4 per cent in end 2011 according to data from SEBI.

Mutual funds also upped their holdings in construction and related project to 4.3 per cent from 3.2 per cent in the above period. Cement, mining and minerals and industrial products are other cyclical sectors that fund houses are no longer shy of increasing their exposures to. The quick rally in September may have seen mutual funds further upping their exposure to cyclical sectors; some of which sported low valuations.

Defensives not out

But this does not mean that fund houses have necessarily reduced their stakes in all defensive sectors. They have either been marginally pruned or have expanded slowly. Take the case of  classic defensive play, software.  Exposure to this sector was reduced from 10.5 per cent in December 2011 to 9.7 per cent in August 2012.  But consumer non-durables or FMCG still saw a marginal increase in the value of equities held by funds. But this could be a result of a rally as well and not necessarily from buying stocks afresh.

If mutual funds provide one cue, foreign brokerages too seem to be taking this route. A recent report by Morgan Stanley Research Asia stated that the firm has moved from being stock-specific to macro specific. With a view to widen its sector choices the firm is adding cyclical stocks and trimming positions in defensives.