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For Investors, Defense Isn't Always the Best Offense

The recent onslaught of negative economics reports and news stories about U.S. economic growth slowing may have many investors considering a more defensive investment strategy to protect their portfolios from volatility. Sounds like a reasonable approach, right?

John Block | Botanica | Getty Images

Not necessarily. Putting more money into the defensive sectors might instinctively seem sensible, but analysts from Standard & Poor's Equity Research caution that focusing too much on defensive sectors could have negative repercussions as well.

"Unless you have a really clear negative trend down in the stock market, it doesn't pay to focus solely on defensive sectors," says Alec Young, a strategist with S&P Equity Research.

"Defensive sectors tend to underperform when the market's doing well and not really distinguish themselves that much in a flat market like we've experienced this year."

And flat is pretty much what the market has been this year, with the S&P 500 down about 1% so far.

While six of the 10 traditional defensive sectors have had positive returns this year, most of those have shown low to moderate growth. As of the market close on Sept. 9, the year-to-date performance of the 10 defensive sectors looks like this:

Industrials: up 7.2%

Consumer Discretionary: up 6.9%

Consumer Staples: up 2.9%

Telecom: up 1.7%

Utilities: up 0.7%

Financials: up 0.6%

Materials: down 1.4%

Health Care: down 5.9%

Energy: down 6.2%

Information Technology: down 7%

"It's a bit of a mixed bag," says Young, who notes that if you focused on the wrong defensive sectors, you could have taken heavy losses.

He says determining the right defensive sectors to invest in is difficult in a market that's fluctuating like this one, which has been marked by several strong rallies and some significant pullbacks. Figuring out when market shifts will occur and which sectors will benefit is like trying to time the market, something individual investors should avoid.

"People buy those products regardless of what the economy is doing"

Of course, that doesn't mean investors shouldn't try to benefit from the defensive sectors at all. S&P is projecting technology and consumer staples to perform better than all other sectors next year.

S&P equity analysts see technology outperforming largely because of pent-up demand from consumers who have delayed purchases of gadgets and from companies that passed on buying Windows Vista and other tech upgrades over the last few years. They see consumer staples as having very dependable sales.

"People buy those products regardless of what the economy is doing," Young says.

Young also points out that these two defensive sectors are a little more global than the rest — they rely less on performance of the U.S. consumer, job market and housing market, which have all been weak lately. Their limited domestic exposure will help their overall performance.

To have a better chance of taking advantage of these defensive sectors, S&P mutual fund analyst Todd Rosenbluth recommends the following funds:

Northern Technology Fund, which was up 13% in the one-year period ended Sept. 10 and has well-known tech stocks among its holdings.

These include Adobe Systems , Cisco Systems , EMC , Google and Oracle

Fidelity Select Consumer Staples Portfolio also enjoyed double-digit returns, posting a 10% gain in the one-year period ended Sept. 10.

Among its top holdings are CVS Caremark , Wal-Mart , Altria and Coca-Cola .

For a more diversified approach to defensive sector investing, Rosenbluth suggests the Calvert Equity Portfolio, which invests in consumer staples, technology and other defensive sector stocks. The fund holds CVS, Cisco and Google, as well as medical equipment maker Stryker from the health care sector and Target from the consumer discretionary group.

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