Kyle Caldwell on investment companies to ride out the economic turbulence.
It's a scenario many fund managers have feared and been preparing for, but we now have to face up to the prospect of the UK falling into recession from the fourth quarter of this year. Things could get even worse before they get better, as the Bank of England warned in early August. Announcing the biggest rate rise in 27 years, the Bank added that the economy will continue to shrink until the end of next year.
Generally, recessions are accompanied by large stock market declines. Therefore, investors need to strap themselves in and prepare for turbulence ahead.
However, this time around the general feeling among fund managers is that while there will inevitably be further bumps down the road, certain parts of the equity market have already moved to price in the impending recession. Therefore, this recession may not be accompanied by a prolonged bear market. Central to these viewpoints is the expectation that high levels of inflation start to cool when the recession hits.
For example, Ian Lance and Nick Purves, the fund managers of Temple Bar Investment Trust, reintroduced an element of gearing at the end of June to increase exposure to the portfolio’s most undervalued stocks, in the belief that the valuations of those shares fully discounted a likely recession.
"The general feeling among fund managers is that while there will inevitably be further bumps down the road, certain parts of the equity market have already moved to price in the impending recessions. Therefore, this recession may not be accompanied by a prolonged bear market."
The duo said: “As fears of recession have mounted, the stock market has anticipated downgrades to profit expectations by pushing down the share prices of those companies likely to be most affected by a combination of lower demand and higher input costs.”
So it would be a mistake to write off equity-focused sectors – such as the UK All Companies and UK Equity Income investment trust sectors – entirely in a recessionary environment.
Moreover, as Job Curtis, fund manager of City of London Investment Trust, points out: “Large parts of the stock market are less cyclical – for example utilities, as people have to carry on paying their water and electricity bills. Another example is pharmaceutical companies; there are also more resilient sectors like tobacco.”
Peter Hewitt, fund manager of CT Global Managed Portfolio Trust, agrees that some UK equities will prove to be recession-resilient. With the threat of a recession raised, Hewitt has recently purchased Finsbury Growth & Income, managed by Nick Train. He explains: “The companies held by Train are big global brand names that have the ability to pass on rising prices. If markets move in a sideways direction during a recession, I think the strategy will perform well in that environment.”
Vincent Ropers, portfolio manager of TB Wise Multi-Asset Growth, is finding value in the riskier mid and small-cap part of the UK market on the grounds that “already a severe recession has been priced in”. His view is that the upcoming recession will be “shallow”, and this could result in a re-rating for investment trusts that specialise in that part of the market. He owns Aberforth Smaller Companies and Odyssean Investment Trust.
“If the recession is severe, then there will be further pain. But I think it may not be a bad way to protect a portfolio by focusing on what valuations are already reflecting, which is a severe recession.”
Ropers adds, however, that diversification is key and that investors should also look to have exposure to more defensive areas, such as healthcare and infrastructure. Both have predictable long-term cash flows. In those areas, he holds Worldwide Healthcare Trust, GCP Infrastructure, JLEN Environmental Assets and Pantheon Infrastructure.
Hewitt is also a fan of both healthcare and infrastructure, highlighting their recession-resilience qualities. On healthcare he points out: “The sector has long-term secular growth characteristics. In a booming economy it is part of the market that may lag, but during a recession it is an area where you are not going to see many big downgrades.”
Another standout sector for those considering adding defensive ballast ahead of a recession is multi-asset funds that invest in a cautious manner. Three examples of investment trusts that invest cautiously and have held up well during previous downturns are Capital Gearing, Ruffer and Personal Assets. The trio have low weightings to equities and plenty of defensive armour, such as low-risk inflation-linked bonds and a small weighting to gold.
Global equity funds could also offer refuge during a recession – particularly if this leads stock markets to tumble. Given that global investment trusts, whether they are income or growth focused, have the flexibility to invest wherever they see fit, such trusts should, in theory, hold up better when markets fall sharply than those constrained to investing in a single region. F&C Investment Trust is a great one-stop shop that has been serving shareholders for generations, and has survived various crises.
