The Bank of England predicts that the UK is likely to enter recession by the end of the year as it continues to raise interest rates to combat runaway inflation.
But what is a recession and what can you as an investor do to protect your portfolio?
A negative economic outlook can weigh on the performance of stocks and shares, and global markets have been choppy for several months.
Since the start of 2022, for example, the FTSE 100 index of major UK stocks is down around 4%. It’s a similar story in the United States, where the S&P 500 stock index is at its lowest level in nearly two years.
To help UK investors protect their holdings from market turmoil, we asked investment experts how best to position a portfolio to weather tough economic conditions.
Remember: any investment is speculative and your capital is at risk. You risk losing some or all of your money.
What is a recession?
In times of economic growth, a country’s gross domestic product (GDP) – the total value of goods and services produced – will increase. However, if its GDP falls for two consecutive quarters, it is defined as being in recession.
Recessions are part of the natural economic cycle of expansion and contraction. The UK previously went into recession from 2008 to 2009 after the global financial crisis and then again in 2020 due to the pandemic.
Jason Hollands, managing director of Bestinvest, said: “There can be different types of recessions, but the one we are entering will almost certainly be caused by falling real incomes as high inflation hits people’s pockets, exacerbated by rising borrowing costs, with higher taxes. adding to the pain.
“Over 60% of UK GDP is consumer-related, so the UK economy is very sensitive to a squeeze in household finances. Inflation, higher interest rates and higher taxes are a perfect storm.
Five tips for investing in a recession
Investment experts from Chelsea Financial Services, Bestinvest and Hargreaves Lansdown have offered the following advice on how best to position a portfolio against the potential damage of a recessionary storm.
- Diversify your portfolio
Diversification across a range of assets such as stocks, real estate, bonds and commodities, as well as different sectors for equity investments, is useful because it can smooth an investor’s average returns if a or more asset classes or particular sectors are underperforming.
Darius McDermott, Managing Director of Chelsea Financial Services, says: “Recessions are all part of the regular economic cycle. For long-term investors, the hope is that you already have a diversified portfolio before a recession.
“There are things you can do to mitigate the risks. You can invest on a monthly basis or buy on dips rather than committing a lump sum to the market all at once, and invest in a range of assets all over the world, as different economies will have different experiences – some better and some worse. ”
- Consider UK stocks
According to Mr. Hollands of Bestinvest, markets are always trying to guess the future rather than waiting for confirmation: “So, to a large extent, recessions have already been factored into equity valuations.
“The UK market is incredibly cheap now, with the FTSE 100 trading at around 8.7 times estimated 12-month earnings, a significant discount to the longer-term average of around 12 times.”
This “before” price/earnings ratio measures the average price investors are willing to pay for FTSE 100 shares relative to their earnings or expected earnings. Therefore, a reduction in the price-to-earnings ratio may indicate that the stock is undervalued relative to its earnings potential.
Derren Nathan, head of equity research at Hargreaves Lansdown, chooses packaging producer DS Smith and pharmaceutical giant GSK like UK stocks that could perform well in volatile markets: “DS Smith is exposed to growth drivers that are not just linked to broader economic growth, such as the transition to more sustainable packaging as well as the potential for growth of online retail.
“Following the spin-off from its Haleon consumer healthcare armGSK now offers purer exposure to specialty drugs, which command high prices.
“We view healthcare as relatively defensive in the current environment and not heavily reliant on consumer purchasing power.”
- Increase exposure to “defensive” sectors
Companies in defensive sectors – consumer staples such as food, beverage and personal care products, financial services and utilities – tend to be less vulnerable to falling demand during recessions. .
Mr Hollands said: “The most resilient segments of the market also include non-cyclical businesses, such as defense and healthcare, which are heavily exposed to government spending and, in the case of defence, which has a backlog of multi-year orders.”
For investors looking to access a ready-made portfolio of companies in more defensive sectors, McDemott chooses Polar Capital Global Insurance and Polar Capital Global Healthcare Trust.
Mr. Hollands emphasizes Growth Liontrust UK and Income from Evenlode TB as options.
- Reduce exposure to cyclical sectors
Investors may also consider reducing their exposure to companies selling non-core “discretionary” products, which are likely to be affected by the current crisis. cost of living crisis.
Mr Hollands comments: “Vulnerable sectors include consumer discretionary stocks, including automakers, airlines, non-essential retailers, as well as the real estate sector, which is eyeing the biggest contraction over the next two years since the early 1990s, with declines of 10-20% expected.
- Focus on experienced fund managers
Hal Cook, senior investment analyst at Hargreaves Lansdown, said: “One of the things we look for in funds is managers with a lot of industry experience and time, because we want to invest with people who have gone through market cycles and experienced different economic markets. monetary conditions and policies that may impact future investment returns.
As an example, Mr Cook cites Stuart Edwards, director of the Invesco Tactical Bond funds, and Jonathan Platt, Director of London Royal Corporate Bonds funds. Both have over 35 years of experience.
What are the “safest” investments during a recession?
Investors may seek to focus on protecting their capital during a recession by investing in cash and bonds, rather than seeking returns on higher risk stocks.
Mr. Cook says: “Money cannot lose value in absolute terms. But in the current inflationary environment, you are lose value in real terms by holding cash.
Regarding other assets, Mr. Dermott says: “Bonds have suffered from rising interest rates. But no doubt the time is near when government bonds – especially those in the UK and US – could once again become a safe-haven asset.
“Yields have already risen significantly, and once central banks stop raising rates, or even cut them due to a recession, bond prices will rise.”
Cook also highlights the potential benefits of invest in gold“Gold has long been considered a store of value: its supply is finite, meaning it theoretically has minimal value and is unlikely to fall to zero.
“Again, the safe-haven argument has always been valid here, with investors often selling off risky assets and turning to gold.”
How can investors make money in a recession?
Mr. McDermott points out that stock markets operate ahead of the economy, meaning they fall as a recession approaches but usually recover first: well done.
“Here, we like Janus Henderson European Small Business, TB Amati UK Small Listed Companies, Artemis American Small Business and abrdn Global Small Business.”
Mr Cook of Hargreaves Lansdown says: ‘Generally it’s not really about making money during the recession itself, but more about positioning yourself to make money as the recession wears off. .
He suggests that investors maintain a long-term investment horizon. He says that while it is tempting to try to time the market and trade safer assets for stocks as the economy improves, in reality this is difficult to achieve.
He therefore suggests investing in fund managers who will oversee allocation decisions for their investors.