One of the more interesting things happening in Canada right now is what economists sometimes call a K-shaped economy.
On one side, the country has technically entered a recession, with gross domestic product (GDP) declining for two consecutive quarters. Wage growth has struggled to keep pace with the rising cost of living, and many households continue to feel pressure.
On the other side, asset owners have generally continued to do quite well. Homeowners, investors, and those with significant stock holdings have benefited from resilient markets. The TSX itself remains relatively strong despite concerns about the broader economy.
That disconnect helps explain why so many Canadians feel like they are experiencing a different economy than the one reflected in stock market headlines. Even so, investors may still want to take some risk off the table.
That does not necessarily mean selling everything and moving to cash. Trying to time the market is notoriously difficult, and many investors end up missing recoveries by sitting on the sidelines too long. A more practical approach may be tilting toward defensive stocks that have historically held up better during periods of economic uncertainty.
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What makes a stock defensive?
Defensive stocks are generally companies operating in non-cyclical industries. In other words, they sell products and services that people continue buying regardless of whether the economy is booming or struggling.
Utilities are a classic example. Most consumers are not going to stop paying their electricity, water, or natural gas bills simply because economic growth slows. That tends to make utility revenues more predictable than those of many other industries.
Consumer staples are another defensive sector. People may delay buying a new vehicle or cancel a vacation during a recession, but they still need groceries, household products, and personal care items.
Healthcare counts, too. Patients generally continue purchasing medications and receiving necessary treatments regardless of broader economic conditions. Unfortunately for Canadian investors, healthcare represents only a small portion of the domestic stock market.
Another way investors measure defensiveness is through beta. Beta measures how volatile a stock or portfolio is relative to the broader market. A beta of 1 means the investment tends to move in line with the market.
Using the S&P/TSX 60 as a benchmark, a beta below 1 generally indicates lower volatility, while a beta above 1 suggests greater volatility. Defensive stocks often exhibit lower betas because their underlying businesses tend to be more stable.
One ETF built around defensive stocks
Rather than trying to identify defensive companies one at a time, investors may prefer using an exchange-traded fund (ETF) designed specifically around lower-volatility stocks. One example is the BMO Low Volatility Canadian Equity ETF (TSX:ZLB).
ZLB uses a rules-based methodology to select Canadian stocks that have historically exhibited lower volatility characteristics. The portfolio is rebalanced every May and reconstituted every December.
Rebalancing means adjusting position sizes back toward target weights. Reconstitution means the ETF reviews the underlying holdings and determines which companies continue to meet the strategy’s criteria.
The portfolio looks noticeably different from the broader Canadian market. Financials remain the largest sector at just over 25%, but utilities and consumer staples rank as the second- and third-largest sectors, each representing roughly 17% of the portfolio. Those sectors receive much smaller weights in the broader TSX, making them key differentiators within ZLB.
As of June 10, ZLB offered an annualized yield of 1.9% while charging a 0.39% management expense ratio (MER). Despite its focus on lower-risk stocks, performance has remained impressive. Over the trailing five years, ZLB delivered approximately 12% annualized returns with dividends reinvested, before taxes.
