Shock-absorber stocks fund managers turn to in tough times

The war in the Middle East rumbles on, with the prospect of months of continuing global economic dislocation even after the critical shipping route through the Strait of Hormuz does eventually reopen.

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In these challenging times, it is inevitable that some companies are more strongly placed than others to weather the storms; some actually gain a tailwind from such disruption.

Christopher Rossbach, managing partner and chief investment officer at J. Stern & Co, outlines the characteristics such businesses need. “Quality companies with strong competitive positions, exceptional management and strong balance sheets can act where others must react, invest where others must retrench and acquire where others are forced to sell,” he explains.

A key part of fund managers’ job is to ensure their portfolios are well diversified, with exposure to these robust defensive stocks helping to mitigate the overall impact of volatility.

UK defensive plays

So, which British companies tick these boxes for managers?

Dominic Younger, who runsCT UK Capital and Income Ord (LSE:CTUK)trust, picks out pest controller Rentokil Initial (LSE:RTO) and global healthcare company GSK (LSE:GSK) for resilient demand and recurring revenues.

Pest control is a service that people need regardless of the economic backdrop, and the market typically grows more than 5% a year, says Younger. “The company has grown both organically and through acquisitions, most notably its transformational deal with Terminix in its core US market.”

Although there have been some integration issues, “Rentokil looks well positioned to turn around performance in its US pest business and begin to harness the full power of the underlying market again. Scale advantages and a growing focus on recurring services underpin profit growth over time.”

Healthcare is an obvious bedrock of defensive investment. “Crucially, demand for medicines is driven by medical need rather than economic cycles, making revenues relatively resilient in uncertain times,” says Younger.

“GSK’s renewed focus on innovation and disciplined commercial execution is driving consistent financial progress. With sentiment towards the shares beginning to improve, we see the fundamentals combining with the valuation to offer a compelling investment proposition.”

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Alan Dobbie, manager of Rathbone Income Fund I Acc (B3Q9WG1) fund, takes a rather different tack to the healthcare sector, with the choice of Primary Health Properties (LSE:PHP), which owns, and develops GP surgeries across the UK and Ireland.

For a start, its properties are let on very long-term leases, with rental income largely underpinned by government funding. But Dobbie points out that PHP also has a structural growth angle, given that much of the primary care estate is no longer fit for purpose, with many buildings predating the NHS itself.

“With public finances stretched, using private capital to deliver modern, purpose-built surgeries allows the government to upgrade infrastructure without significant upfront cost. That creates scope for steady, defensive growth for PHP, alongside a 7.5% dividend yield.”

Supermarket stability

Supermarkets are a popular shock absorber choice, given their focus on everyday essentials.

Younger highlights Sainsbury (J) (LSE:SBRY)’s, where demand tends to remain stable even during downturns.

He points out: “Under current management, the business has been focusing its portfolio around the food retail business, with a substantial amount of progress made in sharpening the price points and value of its proposition, while maintaining innovation levels and quality.

“Strong cash generation is supporting ongoing share buybacks and an attractive yield, reinforcing its appeal as a defensive holding.”

Tesco (LSE:TSCO)is the pick of Callum Abbot, manager of JPMorgan Claverhouse Ord (LSE:JCH) trust. “What really sets Tesco apart is its scale. With around 29% of UK market share, it’s the clear industry leader and buys in far greater volumes than its competitors,” he argues.

“That gives it a meaningful advantage when negotiating with suppliers and allows it to offer strong value to customers. In a weaker economic backdrop, where households are more focused on stretching their budgets, that positioning puts Tesco in a strong place to win share.”

Abbot points out that Tesco also has the financial strength needed in a defensive name, especially in this cut-throat market. “The balance sheet is investment grade, cash generation is reliable, and that supports both a growing dividend and share buybacks. While supermarkets don’t typically have huge pricing power, Tesco’s size gives it more flexibility than peers to manage costs and protect margins.”

Dobbie also favours the food retail sector, and Tesco in particular for its dominance.

“Tesco has shown real discipline, managing costs carefully, investing selectively in price and still protecting profitability. Steady market share gains, achieved against the backdrop of some struggling competitors, reinforce our view that Tesco is the sector’s class act and a decent place to hide when economic uncertainty increases,” he comments.

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Guy Anderson of Mercantile Ord (LSE:MRC) investment trust likes Cranswick (LSE:CWK), a leading supplier of pork and poultry to UK supermarkets. Not only is it too embedded in everyday consumption, helping to underpin demand, but it has a strong focus on production, says Anderson.

He notes: “The company has invested heavily in capacity and automation, allowing it to scale efficiently while improving margins - a clear advantage at a time when rising labour costs are putting pressure on less well-invested peers. This disciplined approach to capital allocation has driven consistently strong returns and a long track record of profit and dividend growth, reinforcing its defensive characteristics.”

Importantly, adds Anderson, Cranswick has achieved resilient performance despite a difficult backdrop for the sector recently, with a 66% total return over the past five years.

Smaller-sized shares with defensive qualities

Certain smaller companies also have defensive qualities that serve investors well during volatility. Paul Jourdan, manager of WS Amati UK Listed Smaller Coms B Acc (B2NG4R3) fund, picks out two contenders.

Serica Energy (LSE:SQZ)is a North Sea oil and gas producer with 11 producing fields, including the Bruce Hub supplying around 5% of the UK’s gas needs. “The commodity price hike is beneficial in the short term given Serica’s modest hedging position and unused tax losses,” says Jourdan, and “there is further upside from the UK government reversing its decision to shut down UK North Sea production early.”

Jourdan also likes SRT Marine Systems (LSE:SRT), a provider of intelligent maritime domain awareness systems for national security agencies, coastguard and fishery authorities. SRT already supplies national authorities across the Gulf states and in Indonesia and the Philippines, with a first contract in Africa.

“Contracts for each country can run into the hundreds of millions of dollars, typically spread over a 10-year period. Drones are already part of its systems, but this is likely to grow significantly as clients re-assess their maritime surveillance needs in the light of events in the Gulf,” he adds.

Global fund managers are also seeking stocks resilient to volatility. Matthew Page, a manager of Guinness Global Equity Income Y GBP Acc (BVYPNY2) fund, suggests Procter & Gamble Co (NYSE:PG), a leading core household essentials provider where “demand remains resilient even in downturns”.

P&G works hard to keep ahead of the competition, he notes. “It spends more than $9 billion (£6.6 billion) annually on advertising and marketing; combined with scale advantages, strong retailer relationships and best-in-class margins, this drives highly stable cash flows and underpins a steady and growing dividend.”

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Dominant global futures exchange CME Group Inc Class A (NASDAQ:CME), with over 95% share in US interest rate futures and index contracts,acts as a different type of shock absorber, says Page. It is “uniquely positioned to benefit from elevated volatility, shifting rate expectations and the current US-Iran uncertainty.”

As he explains, when uncertainty rises, trading volumes increase, driving revenue and earnings momentum as clients hedge and reposition across rates, equities and commodities.

“CME holds diversified exposure across six asset classes, providing a natural hedge. Combined with high margins and strong cash generation, it is a counter-cyclical defensive that can perform well when traditional equities struggle.”

Meanwhile, at Stern & Co, Rossbach chooses two contrasting financial stocks as shock absorbers.

One is digital payments giant Mastercard Inc Class A (NYSE:MA) Although you might expect Mastercard to suffer when global spending declines, it is surprisingly well protected, as “on the transaction side, the secular shift to digital payments provides an inherent offset to short-term contractions in consumer spending”.

Moreover, Rossbach points out the company has “a fortress balance sheet with little to no credit risk, despite a strong track record of tuck-on acquisitions. Although the market has cooled on Mastercard in recent months, the company’s outstanding fundamentals give shareholders a good night’s sleep through the full market cycle.”

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The other, Intercontinental Exchange Inc (NYSE:ICE), operates “the financial plumbing of the digital age – exchanges, clearing houses, and data platforms that become more, not less, essential when uncertainty rises”.

The home of the New York Stock Exchange and holder of the Brent crude contract, more than half ICE’s revenues come from equity and derivatives transactions on its exchanges. Like CME, it benefits from market volatility, as investors react to rapidly changing market dynamics and trading volumes rise.

Importantly, adds Rossbach, ICE has a diverse revenue base, with some “sticky recurring streams” such as fixed income and data services. “Underpinning all of this is ICE’s proprietary data – a vast repository of pricing, risk, and mortgage information that clients depend on daily and that becomes increasingly valuable as AI enhances its analytical applications.”