Defensive Equity (DEF): Low-beta stocks

by Nathan Slaughter, editor The ETF Authority

Claymore/Sabrient Defensive Equity (DEF) holds defensive, low-beta stocks can be a strong ally in uncertain market conditions.

The fund has outperformed nine out of 10 large-cap value funds over the long-haul and kept investors' risks lower than its competitors.

Beta figures help investors gauge the volatility of individual stocks. Any beta reading above 1.0 denotes abnormally large price swings.

For example, a stock with a beta of 1.5 usually captures 150% of the market's gains on an up day, but then suffers -150% of its losses on a down day.

That's exactly where you want to be when the tide is rising. These high-octane names posted huge gains during last year's recovery.

But in most cases, extreme betas belong to speculative companies with shaky balance sheets and/or questionable earnings outlooks. That's why 2009 was widely referred to as a "junk rally."

For the most part, those "junk" days are behind us. Savvy investors have become more discriminating.

Plus, the economy is suddenly looking more fragile than I thought. That's why I started to rotate to higher-quality, low-beta names.

These stocks may not sizzle when the market's hot -- but you love them when it cools off. When the Dow slumped 270 points on July 16, most stocks finished with deep losses.

But steady-eddies like Heinz and Enbridge Energy barely budged that day.

This wasn't an isolated, one-day event. Blue-chips like McDonald's and Waste Management staunchly held their ground during the entire crash of 2008. In fact, both produced positive returns during that harsh environment.

These stocks shine in cloudy markets -- and you'll find each of them in the Claymore/Sabrient Defensive Equity Fund.

This Claymore offering was built to stay on an even keel in the stormiest of seas. The fund invests strictly in stocks with stout defensive characteristics.

Top holdings such as Coca-Cola and Colgate-Palmolive rake in money rain or shine -- recession consumers still buy soft drinks and toothpaste.

These stocks have historically outperformed during bearish conditions. That's not even accounting how the fund offers additional downside protection -- demanding other safety measures like regular dividends, cheap valuations and conservative accounting standards.

Not surprisingly, the portfolio is tiled in favor of defensive sectors such as utilities, master limited partnerships (MLPs) and consumer staples.

But does the beta of 0.83 mean that investors can only expect a gain of +8.3% in a year when the market nets +10.0%?

Not necessarily. DEF has certainly been less choppy than the market. But its positive alpha indicates that returns have been more generous than expected given the narrower price swings.

Beating the market with less volatility is rare, which is why the fund gets strong marks in the risk/adjusted return component of my ETF Composite Scoring System.

But if Greek formulas don't interest you, just know that shareholders took home a gain of +22.3% last year -- not too far behind the market's +26.5% return.

Action to Take -->  Given the cloudier economic picture, I would gladly trade a portion of any upside during the next six months in exchange for proven downside protection.

But DEF isn't just an insurance policy -- the underpriced portfolio is loaded with many of the world's strongest and most dependable businesses.

Learn more about this financial newsletter at Nathan Slaughter's The ETF Authority.