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How can you insulate your portfolio from a recession?


The UK will not enter a recession in 2023, according to the Chancellor Jeremy Hunt – not technically anyway. However, the Office for Budget Responsibility predicts that the economy will shrink by 0.2%.

With such a narrow avoidance of a recession it behoves investors to consider how key fund managers shore up their portfolios against the worst impacts and generally hedge against the threat of recession.

To be fair to the OBR and to the Chancellor, recessions are an inevitable part of the economic cycle and are notoriously difficult to predict, according to Alliance Trust stock picker Andrew Wellington, managing director, consultant relations and institutional sales at Lyrical Partners.

Recessions cannot be avoided

“Since we believe recessions cannot be avoided, we construct portfolios of resilient businesses that we believe can survive the worst of recessions,” he says. “As an example, consider that the average earnings per share performance of our portfolio outperformed that of the S&P 500 in both of the past two recessions.

“Also, we own stocks with deeply discounted valuations, where we believe recession risk is overly priced in the stocks. For some stocks in the portfolio this means recession-resistant businesses that are misunderstood. For other stocks it can mean cyclical businesses that will have a short-term earnings hit in a recession, but go on to survive and then thrive.”

At some point, Wellington says that recessions end, and the companies that survive enjoy the benefits of the recovery and expansion that follows.

“Recessions are not something to hide from, but opportunities to find great values that can offer exceptional long-term returns (even though they may bring some short-term volatility),” he says.

Don’t overpay for stocks

Bill Kanko, founder and president of Black Creek Investment Management (BCIM) says investors can insulate their portfolio from a recession by ensuring they are not overpaying in terms of current valuations for future growth of revenues, earnings, and cash flows.

“We also want to maintain diversification across ideas and business drivers,” he says. “While this does not necessarily mean adding holdings, it means ensuring we can take advantage of future opportunity, but also consider the many risks the current environment poses, including increased geopolitical concerns and uncertainty around the timing and shape of a future economic recovery.”

Having anticipated a recession in 2023 BCIM adjusted it’s financial DCF (discounted cash flow) models to incorporate an earnings downturn in 2023. For cyclical companies, the adjustment was even greater. However, Kanko says out of favour non-US companies, which tend to be more cyclical look attractive as many already have the worst-case scenario priced into their valuation and while US stocks continue to look more expensive broadly, he is finding opportunities.

“We have increased our cost of debt assumptions in our analysis across all portfolio companies and have ensured that companies with debt on their balance sheet have repayments that are further out,” says Kanko. “Share prices will be volatile, but strong underlying business fundamentals should ultimately prevail.”

Preparing for an eventual recession

Rajiv Jain, chairman and chief investment officer at GQG Partners believes there are at least two levers to pull that may help to prepare a portfolio for a potential economic recession.

“First, we can rotate from names in certain pro-cyclical sectors including consumer discretionary and technology to companies operating in more defensive areas such as consumer staples, utilities and healthcare,” he says.

“Secondly, we focus on high-quality businesses, regardless of their sector classification, which we believe are well-positioned to thrive in recessionary environments. These companies are typically characterized by profitability, brand loyalty and strong balance sheets. During recessions, their financial flexibility affords them the opportunity to maintain their research and development budgets to innovate new products and increase their advertising to gain market share.”

Don’t try and predict economic expansion or contraction

Jupiter’s head of strategy for value equities, Ben Whitmore doesn’t try and predict economic expansions of contractions. He says: “The crucial thing we believe is to ensure the business has a balance sheet to protect against unforeseen events. These can range from a recession to Covid. If the balance sheet is strong a company can absorb setbacks and recover. A weak balance sheet necessitates fresh equity capital and / or cutting back on the business. Both of these are damaging to the long-term health of the business.”

CT Fitzpatrick, founder, chief investment officer and portfolio manager at Vulcan Value Partners focuses on investing in businesses with durable, identifiable competitive advantages which generally enables them to produce free cash flow, without a lot of leverage, in most any environment including a period of recession.

“Our intrinsic value estimates may grow more slowly during a recession, but they should remain stable,” he says. “Our companies may even emerge more competitively entrenched through a downturn because they tend to have a strong connection with their customer, deep financial resources, and management teams who allocate capital well while their competitors often are not so fortunate.”

Recession, non-recession or something akin to one, these managers are geared to weather balance out potential hits to returns.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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