Prospector Market Insights

Defining Defensive: Low Beta, or Counter-Cyclical?

Written by Prospector Partners | Nov 18, 2021 4:11:02 PM

With U.S. equities closing in on records again, and with stocks in bull market territory for the better part of the last 13 years, many investors may wonder how “defensive” their equity portfolio is. It’s not an easy question, as there is more than one way to define it.

Our own definition of defensive, and our expectation for our strategies’ performance in market downturns are some of the questions clients and prospects ask us about most frequently. We addressed both in a recent Q&A that tackles some of the questions we get asked most frequently.

It’s a quick read for those wanting to learn more about our unique approach to value investing, but the excerpts below explain how we think about defensiveness:

Your strategies are known for being defensive. Would you define them as low-beta, or counter-cyclical?

We’ll own cyclical companies. We’re defensive because we focus on the balance sheet first and cash flow second. We tend to avoid highly-levered companies. Those traits lead to a collection of more defensive companies — some in cyclical industries — that tend to outperform in tougher markets due to the business’ relative stability. That quality bias also means our strategies tend to have lower beta.

What are the long-term performance objectives of Prospector?  How should we evaluate the firm’s strategies against those objectives?

Regardless of product, the goal is similar: To beat applicable major market indices over a three- or five-year time horizon, and to do so while taking on less risk. Much of our focus is on mitigating losses. We start our evaluation of each stock with an analysis of the balance sheet and are always asking what could go wrong. We seek to earn at least $2 of upside for every $1 of downside in each investment, while at the same time, we seek to avoid investments where we determine there is more than 25% downside. Given the defensive profile of our strategies, we would expect much of our relative outperformance to come during market downturns.

Since our performance during downturns is a critical component of relative outperformance, we think a fair evaluation should take place over a full market cycle. We also believe Sharpe ratios, Sortino ratios, or other metrics that look at risk adjusted returns are instructive in the evaluation of our strategies.

The questions and answers above were part of a Q&A designed to give interested clients and prospects more transparency into the investment process at Prospector Partners. The full Q&A was composed based on the questions we are asked most frequently. To learn more about us, and our unique approach to value investing, we invite you to read the full Q&A.