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Investment Themes Cyclical and defensive sectors

Well-positioned to take advantage of economic cycle.

Companies with cyclical business models benefit in particular from economic upturns. But in an economic downturn defensive stocks are more stable. With the UBS ETF (IE) MSCI EMU Cyclical UCITS ETF and the UBS ETF (IE) MSCI EMU Defensive UCITS ETF, investors can gain an ideal positioning in any phase of an economic cycle. This enables them to benefit from the altered performance of various economic sectors in different business phases.

Companies and their business models react differently to economic trends. Some companies' profits see a sharp rise in an economic upturn, but experience an especially heavy drop when the economy falters. They are considered to be highly dependent on the economic cycle. The term "cyclical company" has been given to these kinds of companies. Their counterparts are called defensive companies. These companies generate relatively stable profits throughout all phases of the economic cycle, but see less of a benefit when the economy expands. Typical examples of cyclical companies range from furniture manufacturers to financial companies. Utility providers and companies from the health care industry are examples of firms that are seen as particularly defensive. Figure 1 illustrates classification of the sectors, where contribution of each sector is assigned 20 percent to ensure an equal representation in the combined portfolio.

Figure 1: MSCI EMU Cyclical and Defensive Sector Indexes

Source: MSCI

Whether a company's business model is cyclical or not also has an impact on the performance of its shares. Historical data, for example, show that:

  • Cyclical sectors feature stronger share price fluctuations, meaning higher volatility, than the equity market as a whole.
  • Cyclical sectors also correlate more with the overall market, and therefore move more in unison with the market than defensive sectors. Cyclical sectors also feature a higher correlation among one another.
  • Phases of outperformance of defensive stocks have alternated with the outperformance of cyclical shares, at least until the financial crisis in 2008. Over the period of financial turmoil, defensive sectors have been considerably more robust. The differences in phases of greater stress, such as at the peak of the debt crisis in the Eurozone, were especially clear.

Figure 2: Comparison of cyclical and defensive sectors over the last 5 and 15 years

Sources: MSCI, UBS Asset Management, as of December 2014. Past performance is no guarantee of future trends.

Taking these kinds of long-term patterns as a basis, the index provider MSCI developed the family of MSCI Cyclical & Defensive Indexes. UBS ETFs now put these indexes within the reach of investors wanting to get involved in the equity market of the Eurozone with two ETFs. With the UBS ETF (IE) MSCI EMU Cyclical UCITS ETF and the UBS ETF (IE) MSCI EMU Defensive UCITS ETF, investors have the option to make tactical use of the developments of sectors in a varying economic cycle.

The two ETFs benefit from the fact that the performance differences between cyclical and defensive sectors tend to return to their historical averages in the long run as in Figure 2. Investors are able to benefit from this pattern by rotating tactically between cyclical and defensive sectors – and back – at the optimal time linked to the economic cycle. 

The UBS ETF (IE) MSCI EMU Cyclical UCITS ETF reflects the performance of equities from five commercial sectors: information technology, materials, financials, consumer discretionary goods and industrials. Given that the ETF is based on the MSCI EMU Cyclical Sectors Capped Index, all sectors are weighted equally at the index adjustment dates taking place regularly, meaning each sector is given a weighting of 20 percent. This helps to offset any possible imbalances resulting from over- or underrepresentation of any sector (e.g. overconcentration in financials or energy). The equal representation of sectors differentiates these investment strategies from the conventional approach, where sector weighting is done exclusively according to the market capitalization of the underlying companies, resulting in sector asymmetries.  

The ETF physically replicates its reference benchmark, meaning it invests directly in the equities included in the index. The total expense ratio (TER) comes out to 0.25 percent per year.

The UBS ETF (IE) MSCI EMU Defensive UCITS ETF reflects the performance of equities from five commercial industries: consumer staples, energy, health care, telecommunication services and utilities. The reference index is the MSCI EMU Defensive Sectors Capped Index. Similarly, the individual sectors are also given an equal weight of 20 percent each at the index adjustment dates.

The ETF physically replicates its reference benchmark, meaning it invests directly in the equities included in the index. The total expense ratio (TER) comes out to 0.25 percent per year.

Cyclical and Defensive Sectors ETFs