Defensive stocks soar as investors choose safety over uncertainty

The weight of FMCG, software and pharma companies in Nifty now at 31.5% from 25.3% in December 2017

The sell-off in the equity markets since the coronavirus disease (Covid-19) pandemic started and the subsequent rally have changed the relative weightings of key sectors in the benchmark indices on Dalal Street.

The composition of the Nifty50 has now tilted in favour of defensive sectors and away from cyclicals such as banks, non-banking finance companies, metals and mines, and automakers.

The combined weighting of three defensive sectors — fast-moving consumer goods (FMCG), software services, and pharmaceutical companies — is now at a three-year high of 31.5 per cent, up from 26.8 per cent at the end of December 2019 and 25.3 per cent at the end of December 2017.

 

Among defensives, FMCG and pharma players have been the biggest gainers. In all, five FMCG companies — Hindustan Unilever (HUL), ITC, Asian Paints, Nestlé, and Britannia — are now in the benchmark index, which is a record.

Experts say investors are preferring safety and choosing defensive sectors.

“There is value across the board, but investors will look at sectors where there is relative safety,” IIFL Chairman Nirmal Jain said.

He also included private-sector banks, well-established financial firms, insurance, pharma, and select information technology (IT) firms among companies that investors would prefer.

Ajay Bodke, chief executive officer of portfolio management services Prabhudas Lilladher, said: “Investors would continue to seek safety in firms that are less likely to be affected by an economic downturn.”

FMCG companies have now overtaken tech firms to become the largest component of defensives in the index, followed by pharma companies.

Among companies, HUL has been the biggest gainer as it now accounts for 4.1 per cent of the Nifty50, up from 2.6 per cent at the end of calendar year 2019 and 2.3 per cent at the end of 2017.

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Nestlé’s share increased to 1.6 per cent, from around 1 per cent at the end of last year.

In pharmaceuticals, Dr Reddy’s has been the top gainer, with its index weighting reaching 1.2 per cent, up 50 basis points (bps) from December 2019.

In software services, Infosys’ weighting has gone up 100 bps to 6.2 per cent, from 5.2 per cent at the end of December 2019.

Defensives could have gained even more if not for the relative underperformance of ITC and Sun Pharmaceutical Industries (Sun Pharma).

ITC’s market capitalisation is down 45 per cent in last three years, while Sun Pharma has lost 58 per cent of its market value since its all-time high in March 2015.

A company’s index weighting is decided by its free-float market cap, which is a function of its market cap and non-promoter stake. This gives ITC a greater share in the index than HUL even though its market cap is now less than half that of the latter. The non-promoter stake in ITC is 100 per cent, against 32.8 per cent in HUL.

The financial sector has been the biggest loser with a decline of nearly 700 bps in their index weighting since the end of December 2019.

Lenders such as HDFC Bank, State Bank of India, ICICI Bank, Housing Development Finance Corporation, and Bajaj Finance now account for 33.5 per cent of the index, down from a record high of 40.6 per cent at the end of December 2019.

Automakers have been losing their share in the index for a while. They now account for 4.8 per cent of the index, down from a record high of 10.9 per cent at the end of December 2016.

It coincided with the underperformance of metals and mining, which now accounts for 2.5 per cent of the index, down from 4.3 per cent at the end of March 2017.

Analysts expect defensives to continue to increase their dominance in the indices.

“Rising valuations are a function of risk aversion in the market,” said Bodke. This is despite some consumer firms having stated that capacity utilisation has been hit by the pandemic. IT firms have suspended their revenue guidance, declining to project how business might fare in the midst of Covid. Valuations are likely to remain elevated while uncertainty persists, even as earnings remain a concern, he added. 

“There will certainly be a correction in valuations for defensive firms, but for that the market has to stabilise,” he said.

A higher share of defensives is likely to reduce volatility in the index because stocks in these sectors react less to macroeconomic news.