Top stock-picking fund managers won 2015 by aiming for brand name companies and avoiding the sector bets that brought down biotech and energy investors.
Now, as they look ahead to 2016, these active investors expect to be even more defensive, picking companies like Hersheys Co and General Electric that they say will be able to weather the combination of slow global growth and the first U.S. interest rate hike in a nearly decade.
"We're looking for companies that have some competitive advantage that makes them the standard in their industry," said Dennis Lynch, a co-portfolio manager of both the Morgan Stanley Institutional Advantage fund and the Morgan Stanley Institutional Growth Portfolio fund—the fifth and sixth best performing large cap funds of this year with returns of 11.5% through Monday's close.
Lynch's Institutional Advantage fund, for instance, added positions in consumer companies including Hershey, Estee Lauder Companies Inc and Colgate-Palmolive Co in the quarter ending Sept. 30.
These types of consumer companies with strong brands tend to withstand volatile markets, Lynch said. At the same time, he trimmed positions in top holdings Amazon.com and Facebook that rallied this year.
Other active fund managers that are looking for big names with lots of downside protection in 2015 include Daniel Davidowitz, co-portfolio manager of the $804 million Polen Growth fund—the year's top performer in the large cap category—and Douglas Rao, portfolio manager of the $2.4 billion Janus Forty fund.
"There's a lot of noise and volatility in the market right now, and we're in the position of trying to find companies that are less sensitive to the macro environment," said Rao.
Rao's fund gained 10.7% for the year through Monday, a performance that was the 10th best among large-cap funds tracked by Lipper during a time when only 24% of large-cap funds have been able to outperform the 0.1% gain in the index this year, according to Lipper data.
Much of Rao's performance came from his top holding, Google parent Alphabet Inc, which has gained 44% for the year to date, and Amazon, which more than doubled this year and accounts for his 8th-largest position.
Yet Rao is not searching for the next stock to hit out the lights in 2016. Instead, he expects GE to once again outperform in the coming year as it sheds its GE Capital assets faster than analysts expect and turns more of its focus to segments such as expanding its line of industrial software.
"The fact is that we have an opportunity to build a position in what we think will be a best of breed industrial company during a period where the U.S. is going through an industrial recession," he said.
'When the Seas Get Rough'
The Polen fund is aiming straight at all-weather stocks: All 20 companies in its portfolio generate high levels of cash flow, return 20% or more on capital and show increasing profit margins and organic revenue growth.
Along with Facebook, Adobe was the only company Davidowitz added this year to his portfolio, which bested all large-cap funds tracked by Lipper with a gain of 13.4% through Monday. Much of that performance came from top holding Nike Inc, which has gained 36.4% for the year to date, along with large positions in Starbucks Corp - up 45.6% - and Visa Inc, up 17.7%.
"We aren't built to try to take advantage of rate hikes or oil prices or anything like that," he said. "We want companies like Adobe where it is hard for a competitor to pull their customers away."
That approach may be especially important in the year to come. Since 1945, the benchmark S&P 500 has gained an average of 4.5% over the 12 months following the first rate hike of a business cycle, or about half of the 8.8% average gain for the index among all years, according to data from S&P Capital IQ.
"There's an old saying that when seas get rough sailors prefer a larger boat, and we may have investors gravitating toward larger-cap companies because they expect even rougher seas ahead," said Sam Stovall, chief equity strategist at S&P Capital IQ.