Increases in the density of woody plants are a global phenomenon in drylands, and large aggregations of shrubs, in particular, are regarded as being indicative of dysfunctional ecosystems. There is increasing evidence that overgrazing by livestock reduces ecosystem functions in shrublands, but that shrubs may buffer the negative effects of increasing grazing. We examined changes in water infiltration and nutrient concentrations in soils under shrubs and in their interspaces in shrublands in eastern Australia that varied in the intensity of livestock grazing. We used structural equation modelling to test whether shrubs might reduce the negative effects of overgrazing on infiltration and soil carbon and nitrogen (henceforth ‘soil nutrients’). Soils under shrubs and subject to low levels of grazing were more stable and had greater levels of soil nutrients. Shrubs had a direct positive effect on soil nutrients; but, grazing negatively affected nutrients by increasing soil bulk density. Structural equation modelling showed that shrubs had a direct positive effect on water flow under ponded conditions but also enhanced water flow, indirectly, through increased litter cover. Any positive effects of shrubs on water flow under low levels of grazing waned at high levels of grazing. Our results indicate that shrubs may reduce the adverse effects of grazing on soil properties. Specifically, shrubs could restrict access to livestock and therefore protect soils and plants beneath their canopies. Low levels of grazing are likely to ensure the retention of soil water and soil carbon and nitrogen in shrubland soils. Copyright © 2015 John Wiley & Sons, Ltd.