Hey there, Dan again, back at you with another edition of the ETF Insights newsletter.
For this month’s newsletter, I’m going to cover a topic that has been very popular over the last few months, primarily due to the large run-up in the markets overall, coupled with many defensive stocks taking a back seat and experiencing price drawdowns.
Obviously Waste Connections doesn’t not encompass the entire defensive sector of the market, but I’ll show you a chart here to give you an idea of what I mean.
Several defensive ETFs appear fairly valued right now, following a large run-up in price over the last few years due to economic uncertainty. Military budgets are up, consumer staples are steady, and utilities continue acting like bond proxies.
Cash flow stability is the big deal here. These funds are built to smooth out volatility, not chase the hottest growth stories.
As I have mentioned numerous times in the past, I view defensive stocks as a staple within a portfolio, not necessarily something you rotate in and out of. Sure, we’re not going to realize the large-scale returns we would from growth stocks, but when the markets get rocky, people are often thankful they hold defensive elements.
Look no further than the chart below, highlight the BMO Low Volatility ETF (TSE:ZLB) and the iShares Minimum Volatility ETF (USMV) versus the S&P 500 and NASDAQ in the 2022 bear market.
Overall, we’re trying to construct a portfolio that is greater than the sum of its parts. What I mean by this is the combined entity of our portfolio functioning as a cohesive unit, allowing for the maximum returns possible with the lowest level of risk.
How “low” that risk is solely depends on the individual and their risk tolerance.
The case for defensive plays feels stronger with economic growth slowing and central banks signaling a softer stance. If the economy dodges a deeper downturn, however, these funds will likely lag the index.
This is solely why I never really advocate for “rotating” in and out of defensives. Just hold a particular portion of your portfolio in them, and let them do their thing in the background.
I think some ETFs fit best in a long-term, defensive bucket, especially when paired with growth holdings.
Let’s dive into defensive funds, including previous performance, why they might deserve a fresh look, and a couple of funds you can review if you are looking to add.
Why Defensive ETFs Deserve a Fresh Look in 2025
Markets look steadier, but the backdrop hasn’t really improved. Consumer sentiment keeps sliding, inflation expectations are still sticky, and trade tensions are just adding more noise.
Yet, we sit at all-time highs in the markets. I would bet good money this is why I have had so many inquiries about defensive options. Defensive positioning starts to look a lot smarter to investors than chasing momentum.
Shorter‑duration bond ETFs and high‑quality government debt still act as a safe haven when things get choppy. However, returns are historically lower than those of equities, and I will be basing this newsletter on the idea of long-term equity-based defensives.
On the equity side, defensive ETFs fall into a few clear categories:
- Low volatility or minimum volatility funds
- Sector funds tied to consumer staples, healthcare, or utilities
- Quality, low volatility, or value funds that emphasize stronger balance sheets
Each of these has a role, but the fit really depends on whether you treat them as a hedge or a strategic long-term allocation. Again, as I’ve mentioned numerous times previously, I prefer the latter.
Rotating in and out of them is a form of marketing timing. And we know how that works out for the vast majority of retail investors. However, if you have been looking to add defensive ETFs as a staple to your portfolio, you’re certainly getting a better price now than you were 6 months ago.
How Defensive ETFs Perform During Rate Cuts and Economic Slowdowns
When central banks cut rates, the yield environment shifts in ways that usually help defensive ETFs. Utilities and consumer staples tend to hold up because their cash flows don’t swing wildly with economic cycles. In addition to this, these companies often have higher debt levels, and lower rates ultimately means lower interest expenses.
The effect isn’t guaranteed, though. Breaks in patterns can happen if inflation stays sticky or forward interest rate expectations change quickly.
I already showed you the 2022 bear market. But here is those two funds in the sharp 2019 correction we faced.
Or the correction in 2015.
These charts highlight how well defensives perform during heightened market volatility.
I wouldn’t necessarily say the desire to buy defensive ETFs comes from an economic situation this time, however.
The bulk of it comes from a desire to hedge against potential market overvaluation. There is no doubt about it; AI is ruling the markets right now, and some companies, including some of the largest in the United States, are reaching nosebleed level valuations.
Combined with margin debt at all-time highs and the Goldman Sachs Speculative Trading Indicator at its highest level since 2021, I gather that investors are concerned more about market valuations than they are about inflation or an economic downturn.
So, it isn’t easy to compare these two situations. Defensive stocks tend to outperform the markets during periods of weaker economic growth. But now, we have a situation where economic growth might be just fine, but the markets have gotten a little too “happy” about the future growth, and have priced most of it in.
Low Volatility ETFs Simplify Defensive Holdings
When the markets feel stretched, the traditional playbook is to own defensive sectors. Think of a utilities ETF or a consumer staples ETF.
However, there is a challenge here. Building a defensive allocation this way can mean juggling multiple sector-based funds and determining how much weight to give each.
I am a huge fan of low-volatility ETFs, as they offer a much cleaner solution, passing off the nuances of rebalancing and decision-making to the fund manager.
Rather than betting on any one defensive sector, they screen the entire market for stocks with historically lower price swings.
The result is a diversified portfolio tilted toward the same kinds of companies investors often seek in downturns. Utilities, staples, healthcare, or large-cap dividend payers, but without the need to manually assemble and rebalance them.
Remember, we’re ETF investors. We aim for the minimal amount of work possible, while maximizing returns.
In past bear markets, minimum-volatility funds have generally lost less than the broad market. They won’t avoid losses altogether, but they can smooth the ride and reduce drawdowns compared to a broad-based index fund or an all-in-one fund.
Top Defensive ETF Options
Now to the bread and butter of the newsletter, which is some defensive ETFs you can consider for your portfolio if you’re looking to beef up your position.
Canada
One interesting aspect of Canada is that our defensive holdings are often some of the best stocks in the country. Our large-cap stocks are dominated by elements such as grocers, banks, utilities, and pipelines. So, if you currently own a Canadian index fund, it is likely you are already defensively allocated in Canada.
However, the fund I always fall back on in terms of reliability and solid returns is the BMO Low Volatility ETF, which trades under the ticker ZLB.TO.
The fund contains some of the best blue-chip stocks in the country. It excludes volatile items within technology and energy that lack defensive characteristics.
What you will notice about this fund is that it has underperformed the TSX Index over the last while after a long string of providing exceptional risk-adjusted returns.
The bulk of this is due to the fund’s lower concentration in financials, which have soared over the last few years. And it has lower exposure to the material sector than the TSX Index.
What are arguably the two best-performing sectors of the index over the last couple of years?
Financials and Basic Materials, primarily gold.
Gold is an easy one to complement ZLB with. You could look to add a fund like ZGLD, which tracks the price of gold bullion.
United States
What steers people away from defensive ETFs in the United States is primarily a lack of performance relative to the S&P 500.
In Canada, we don’t have the booming tech sector the US does, so a low-volatility ETF like ZLB has historically even outperformed the TSX.
With the US funds, we’re investing in a lot of slower-growing, mature businesses that often revolve around the “real” economy, that being companies that are involved in the movement and consumption of physical goods. Most technology companies are involved in the sale of digital goods.
Because of how much technology has driven the S&P 500’s returns over the last while, a lot of minimum/low-volatility defensive ETFs in the United States have substantially trailed the S&P 500.
However, they have still provided outstanding returns from a risk-adjusted standpoint, and someone looking for a lower-volatility defensive mix might want to focus more so on the fund itself rather than its underperformance relative to the index.
One of my favorite funds in this regard would be the iShares MSCI USA Minimum Volatility ETF, trading under the ticker USMV.
The fund has around 180 companies, and no company in particular has a weighting of over 1.5%.
The unique part about USMV is that it still contains some of the big tech names like Microsoft and Nvidia. However, their positions are small enough that any substantial swings in price would be unnoticeable from a volatility perspective.
The fund has returned 10%~ annually over the last half-decade. And what I find interesting is that this is something that would have been considered an exceptional return, if not for the S&P 500’s 16%~ annualized returns over that same timeframe.
The large separation in terms of total returns from this fund to the S&P 500 is virtually all after April of 2025. This makes perfect sense, as growth stocks have seen massive inflows and defensive stocks massive outflows since that time.
I wouldn’t discount this fund based on past performance. In fact, the significant deviance in terms of performance is what would make this fund possibly more attractive, in my opinion.
The Key To A Resilient Portfolio is a Bit of Both
I don’t like to look at defensive options and growth options as opposites. Leaning too far into either side leaves your portfolio vulnerable to underperformance.
If you go too heavy into growth, market drawdowns can wipe out gains at a rapid pace. A couple of years of exceptional performance can be erased in a single bear market.
I’ve known many popular YouTubers who ran portfolios up quite a bit but faced 50%+ drawdowns in 2022. And remember, a 50% drop in price requires a 100% return to get back to the same level.
On the flip side, if you go too defensive, you’ll likely end up with weaker performance.
The balance comes from using growth assets to drive returns, and defensive holdings act as a buffer when markets turn.
I use Fortis as a prime example. This is a core holding in my portfolio. I know Fortis won’t be beating the market for me over the long term. But I also know if the markets fall 20%, 30%, 40%, or lower, Fortis won’t fall that much.
Where I find investors tend to overthink things is shifting too far into one direction or the other, believing they can simply time the market. If you are an investor who holds broad-based index funds and you fear a potential market correction, shifting into defensives might work out, or it might not.
As I’ve mentioned in the past, when it comes to timing the market, you either get lucky or you’re wrong.
Instead, if you’re looking to beef up your portfolio with a bit more defensive options, maybe add a fund or two as a satellite holding. What I mean by this is a fund that complements your core holdings, such as your S&P 500 funds, your all-in-one funds, or your TSX funds.
The compulsion to tinker is a universal human impulse. We always want to position ourselves for the best chance to succeed. However, sometimes we end up going a bit too far in one direction and pay the price.
If you feel defensive options might outperform over the next year or two, a suggestion would be to make a smaller “bet” on this activity via a satellite ETF to your core portfolio rather than betting the entire farm on a defensive play. It seems tempting, as if you’re right, you look like a genius, and your returns will certainly show that, but if you’re wrong, you could miss out in a big way.
