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How to recession-proof your investment portfolio

by Ryan Hughes
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This year, investors have had to contend with stock market losses, skyrocketing inflation, an energy crisis thanks to Russia’s war in Ukraine, and turmoil in UK financial markets after a disastrous mini-budget.

Since the start of the year, the S&P 500 is down more than 20pc, putting it firmly in bear market territory, while global bonds are down 17pc in euro terms. 

“At the end of last year, even the lowest risk-investors – those with portfolios that had exposure of just 20pc to 30pc to equities – would’ve been up on the year,” says Kevin Quinn, chief investment strategist at Bank of Ireland. “2022 has been a completely different story.”

Now, with central banks in the US, UK and the eurozone on an interest rate-hike frenzy in an effort to tame inflation, more economists are warning that a recession is on the cards. Instead of waiting for this contraction, you can prepare your investment portfolio to stave off the damage from a global recession – and perhaps even come out on top. Here’s how to protect yourself amid the coming economic storm.

1 Check your risk levels

You have to accept some level of risk when you make an investment. But check that your risk appetite still matches your long-term financial goals. For instance, if you’re planning an earlier retirement than you originally intended, it would be wise to reduce the level of risk in your portfolio.

“The first step to recession-proofing any portfolio is to make sure that you are running an appropriate and tolerable level of risk,” says Christopher Jeffery, head of inflation and rates strategy at Legal & General Investment Management. “Being forced to close out an exposure under duress is one of the most assured paths to losing money.

“Investment strategy is about balancing and mitigating risk, not avoiding it completely – fully recession-proofing a portfolio is likely to involve a significant decrease in expected return.”

2 Diversify

The aftermath of the 2008 financial crash was littered with high-profile people who lost their shirts because they had bet their personal fortunes on individual bank shares instead of having a well-diversified portfolio.

“Having too great an exposure to one type of investment leaves you vulnerable to sudden swings in the market and changes in outlook,” says Richard Flood, investment manager at wealth manager RBC Brewin Dolphin in Dublin.

“Spreading your money across a range of asset classes, including shares, bonds and cash, can help to reduce volatility in your portfolio. The idea is that if one part of your portfolio isn’t performing well, other investments might compensate for losses.”

But even professional investors struggled to get diversification right during this year’s turbulence. Historically, government bonds behaved as safe havens during times of economic turmoil but this year’s bond markets have turned the traditional wisdom on how to diversify a portfolio on its head.

“There’s plenty of long-worn lessons about diversification being the only ‘free lunch’ but it hasn’t worked out this year,” Quinn says.

“Fixed income usually provides balance in portfolio and the drop in value is unusual and unprecedented. But other things have worked, like the strength of the dollar. If you held a global equity index and close to 60pc was US equities, you had losses in global equities but they were offset by the gain from the dollar.”

Because the price of bonds has fallen this year, some fixed-income products may represent an opportunity to investors looking to buy them on the cheap.

“Investment-grade corporate bonds (those issued by corporations with good credit ratings) and sovereign inflation-linked bonds are two examples of relatively low risk assets that have repriced significantly,” Jeffery says.

“Fixed-income assets were so expensive last year that they were unattractive. That is no longer true with yields now higher.”

In times such as this, professional investment managers tend to shield their clients’ wealth by investing much more in alternative assets, such as private equity investments, hedge funds, commodities and property.

“Commodities have been doing well,” says John O’Toole, global head of multi-asset fund solutions at Amundi. “Many retail investors can’t access commodities but there are other ways of benefiting from them, such as investing in commodity-producing countries.”

3 Opt for stocks that can weather economic storms

In a recession, some sectors are more resilient than others. For instance, those that rely on discretionary consumer spending, such as hospitality and leisure, might perform worse than makers of consumer staples such as Procter & Gamble, which manufactures toilet paper, deodorant, toothpaste, detergents and nappies.

Healthcare and pharmaceuticals are also typically more resilient because people get sick or injured no matter what stage of an economic cycle a country is in. And just like basic food, hygiene products and healthcare, energy companies will perform well because we can’t do without electricity. It also has pricing power  in an energy crisis.

Quinn says: “The energy sector is up 48pc and tech is down 21pc, so there is a spread of nearly 65pc in 2022 in how energy and tech have performed. If you had decided at the start of the year to invest in energy stocks, you would have done rather well.”

When it comes to investing in individual stocks, many wealth managers seek out value, preferring companies with strong cashflow rather than those with a long-term growth potential that may never materialise.

O’Toole likes quality, value stocks that show the potential for sustainable earnings growth and reward shareholders with dividends even in a downturn.

4 Hold some cash

“If you rely on your investments to fund your retirement or deliver an additional income stream, a stock market downturn can be especially alarming,” Flood says.

“One way to minimise shocks to your portfolio is to maintain a cash cushion.”

Quinn recommends always having six months of available cash during a downturn for an emergency, such as loss of employment or worsening health.

5 Don’t make rash decisions

When financial markets are volatile and a recession is on the horizon, it’s tempting to panic and sell out altogether. But by doing so, you could miss the rebound, Flood says.

As billionaire investor Warren Buffett famously said: “The stock market is a device to transfer money from the impatient to the patient”.

6 Staying ethical

Funds that take into account companies’ environmental, social and governance (ESG) practices – once the hottest trend in investing – are suffering a backlash. Investments that promise to do better by the planet and by people have faced claims of greenwashing, sub-par returns, and a lack of reliable data.

US and European regulators are starting to crack down on claims made by fund creators as they strive to weed out funds that are inappropriately labelled ESG. Last month BlackRock, in response to accusations by some Republican states in the US that the world’s largest asset manager is “boycotting” oil and gas companies, highlighted that companies which manage their exposure to climate risk and that capitalise on opportunities will have better long-term financial results.

Indeed, studies show that ESG investments result in comparable – or even better – returns than investments that only take into account financial factors. Bloomberg Intelligence estimates that global ESG assets are set to jump from $35tn (€35.2tn) today to $50tn in 2025.

Christopher Jeffery, head of inflation and rates strategy at Legal & General Investment Management, says despite current volatile market conditions, investors should still pay attention to ESG considerations.

“All investors, retail and institutional, should not lose sight of their investment objectives, beliefs and time horizons when markets are turbulent,” he says. “Predicting when ESG risks will crystallise is tricky, but any such fault lines in economic and corporate structures are more – not less – likely to be exposed in a bear market.”

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