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Investors need to be a bit wary of piling into so-called recession-proof stocks for two reasons.
First, as the economist Joseph Stiglitz once noted, ‘the only perfect hedge is in a Japanese garden’ and something can still go wrong at a company even if its business is, in theory, fairly insensitive to the cycle. Competition can arrive, the regulator can get involved, management can make a poor (or overpriced) acquisition or something entirely unexpected can happen – such as a pandemic.
Second, investors priced in a recession during the market collapse of February and March and the Q2 GDP number was no surprise to anyone. The debate has moved on to the shape and pace of the recovery, since economists expect the recession to have ended in Q2, especially as May and June both showed sequential increases in GDP and June’s rate of growth beat forecasts.
Potentially ‘recession proof’ stocks or funds are therefore more likely to come back into their own if the pandemic persists, the number of local lockdowns grow and growth disappoints or – worse – GDP keeps falling. Even then, fiscal stimulus from Government or monetary stimulus from the Bank of England could give cyclical stocks a boost, in the view such efforts will boost growth, but a balanced portfolio could always do with some ballast, just in case.
Shares
Looking for firms which have strong balance sheets and business models where demand is relatively insensitive to the economic cycle can be a good start here.
If the recession lingers or deepens, it seems very likely that Governments will spend more, increasing their already substantial budget deficits, and central banks will swing into action with more Quantitative Easing and unorthodox monetary policies. If history is any guide this is prime territory for gold, given its perceived status as a haven and also a store of value. The Egypt-based FTSE 250 gold miner has just hiked its interim dividend by 50% to show what could happen if the precious metal keeps rising in price, as in the first half a 9% increase in output turned into a 56% jump in sales and a 280% leap in net profits thanks to higher gold prices.
The company is the UK’s largest pawnbroker and that operation represents roughly half of revenues. The rest of the business is represented by the retail operations, selling new and second-hand jewellery from physical stores and online, plus personal loans, as well as some gold purchasing, foreign exchange and cheque cashing services. H&T provide a potentially valuable service to those who do not have access to traditional High Street or online banking facilities and its business should prove resilient in the event of any prolonged economic downturn owing to the pandemic. A double-digit return on capital and strong cash conversion highlight the strengths of the business, where the pawnbroking shops are reopening after the lockdown, although an increase in loan impairments could be a risk to consider, in the event of a long, deep downturn, although H&T pro-actively helped customers during lockdown with interest holidays and payment deferrals.
The FTSE 250 constituent invests in, and works to commercialise, the intellectual property (IP) developed by British universities. The well-documented travails of a well-known fund manager may have put many investors off investing in early-stage companies for life and IP Group is not suitable for all investors - there is no dividend and there are also clear capital risks associated with investments in young firms, as they may fail or require further investment and soak up more cash even if they make progress, while even successful investments can take a long time to realise their potential. However, the portfolio is progressing well, as shown by the rising valuation of Oxford Nanopore and the sale of a stake in Ceres Power, and the economy will have little influence on many of the fledgling firms that IP Group is backing. Better still, the balance sheet is net cash and the shares trade at a 32% discount to net asset value, which is a good start when it comes to looking for downside protection.
Utilities can often be a port in an economic storm, thanks to their relatively stable business flows and the income they offer at what remains a period of considerable economic uncertainty, and FTSE 100 member Severn Trent could be a good example. The water provider’s capital spending is expected to drop in the coming year from a ten-year high of £800 million to around £470 million, at the mid-point of management guidance, upon completion of the AMP6 regulatory cycle. Regulator Ofwat’s move to give fast-track approval for Severn Trent’s spending and pricing plans for AMP7, which runs from 2020 to 2025, also bodes well in this regard and provides plenty of visibility on long-term cash flow, which should help to reassure shareholders. There is a risk of unpaid bills in the event of a really deep recession but Severn Trent’s 3.9% prospective dividend yield may still appeal to many long-term investors, especially as the Bank of England continues to float the dreadful idea of negative interest rates.
A sound balance sheet is always a good start as it provides downside protection and Telecom Plus has barely £50 million of net debt, including leases, £55 million in further borrowing available and no debt to repay until 2023 at the earliest. That takes the pressure off and the FTSE 250 multi-utility provider model seems robust and proven over the long term, as it seeks to provide good value to customers and also offers the convenience of a single bill across its energy, telecoms and insurance services. Demand should prove relatively resilient, even in the event of an economic downturn, although investors will want to keep an eye on possible bad debts, if a really deep recession hits the country and customers find it harder to pay their bills. A commitment to an annual dividend of 57p a share this year could also please income-seekers.
Funds
Investors who prefer to diversify via funds rather than pick specific stocks might prefer to consider Investment Trusts or Funds run by managers whose investment styles could do well in a downturn and help to protect their money during any falls.
Run by Troy’s Sebastian Lyon, the £1.29bn trust invests in a range of assets including high-quality companies, short-dated government bonds, cash and gold. It currently has about a 5% of the portfolio in cash, 9% in index-linked bonds and 10% in gold, meaning it is positioned defensively. Mr Lyon focuses on avoiding loss of capital, as well as giving an instantly diversified portfolio in just one holding.
Janus Henderson UK Absolute Return
This £1.4bn fund has held up well in recent market volatility and protected against losses – since the start of the year it has gained 2% when markets have generally fallen. The fund aims to deliver a return above zero, typically over a 12-month period, and has managed to do so every year for the past 10 years. Managers Ben Wallace and Luke Newman have the ability to have a significant amount in cash, to protect against stock market falls, and to ‘short’ stocks to help when markets are falling.
The fund invests in around 40 large companies around the globe, offering some diversification between different countries and markets. The fund managers hunt out holdings that have low levels of debt, high profits and require less capital to operate than their competitors, meaning they should be better placed to survive a downturn. While 37.7% of the £600m fund is invested in US firms and another 20% in UK companies, there’s a spread across smaller European and Asian markets too.
Past performance is not a guide to future performance and some investments need to be held for the long term. These articles are for information purposes only and are not a personal recommendation or advice.
Written by:
Russ Mould
Russ Mould has 28 years' experience of the capital markets. He started at Scottish Equitable in 1991 as a fund manager and in 1993 he joined SG Warburg, now part of UBS investment bank, where he worked as equity analyst covering the technology sector for 12 years. Russ joined Shares in November 2005 as technology correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media by AJ Bell Group, he was appointed AJ Bell’s Investment Director in summer 2013.