Where to Invest During a Recession?
04th May 2020 |
What should people do about their investments when the world economy is entering a period of recession and global share prices start to display some recovery, where to invest in an apparent bear market can be confusing and often spark knee jerk reaction!
As a direct result of Covid-19 countries around the world have been forced into huge Government monetary and fiscal support, stock markets have entered bear territory and a global recession is most likely inevitable.
So, what should people do about their existing or new investments, and where does a bear market offer opportunity?
Emotional Reaction
With worrying financial headlines along with the continued COVID-19 challenges, many investors will instinctively reduce their investment risk at least in the short term, but others will jump head-first into cash funds, which is all too often an emotional reaction caused by fear.
It’s instinctive that when faced with a threatening situation, our response is fight or flight. But, like trying to outrun a bear, exiting the market after suffering losses is not a good idea. It often results in selling at low prices and buying higher later once the market stress eases, so before deciding on any rash changes always speak to your financial advisor first.
Timing the Markets
You could wait for the equity markets to hit bottom and then swoop in and make a killing, provided of course your crystal ball is working. Sure, the markets were overpriced and an adjustment was overdue, indeed, as we already pointed out to our clients due to early signs of COVID 19, last December was a good time for a risk review, but no one can truly time the markets!
At this point, investors should keep cool heads diversifying and matching their current risk profile to both their investment time horizon and the importance of that particular investment i.e. its actual goal.
Most Irish people working or retired own stocks either directly or through institutional investment vehicles such as unit-linked (mutual) funds held in pension plans and approved retirement funds (ARF’s), but many lose sight of the importance of proper long term risk management when a stock market crash occurs and the headlines seem to only spell doom.
The fact is a basic understanding of risk which includes Fund Management Strategy, Asset Diversification, and Volatility measures can assist with their personal investment outcomes in all economic and market conditions, while it is also important to understand that you can stay partly invested in equities, but still be defensive.
Food and personal care stocks often called “defensive stocks,” usually do well in a bear market as people buy more of what they need as opposed to what they want, whereas technology, pharmaceuticals, and health should still do well in the current climate, even if other sectors are losing value.
Other asset classes, like Gold, is a high-risk asset like equities but for some could act as a small percentage hedge if suited to your portfolio and risk attitude, whilst Bonds which sit at the lower end of risk, including long-dated Government Bonds that may well suit longer time horizons.
Property in the right geographical locations could offer value in time, but this would is more likely to be a patient ask.
Positioning Your Eggs
All asset classes carry a level of risk directly correlated with their return potential with the main asset classes applicable to unit-linked Investment Bonds, Pension Plans and ARF funds being:
Equities: investment in company shares.
Property: bricks and mortar, property equities or REITs (Real Estate Investment Trusts).
Commodities: e.g. gold, copper, water infrastructure and agriculture.
Alternatives: e.g. emerging market equities, or absolute return funds.
Bonds: loans to companies or governments.
Cash: money on deposit.
Ask any investment professional, and they will likely tell you that one of the most important ways to reduce your risk is through diversification.
Active V Passive Fund Management
Active funds are ‘actively’ managed by a fund manager, who buys and sells investments on behalf of the fund in order to maximise gains and minimise losses. As the fund is actively managed, the fund managers can strategically react to market situations, taking advantage of insights and opportunities as they happen.
Rather than trying to anticipate and identify growth opportunities, passive investment funds simply track a particular stock market index.
It is often cited that the average active investment manager does not outperform their passive equivalent, but the truth is it depends on the timeline under consideration as well as the active fund manager or managers chosen.
Index (passive) funds have an advantage with their slightly lower cost structure and broad exposure that limits single stock/concentration risk, but once volatility kicks in, that is where active strategies can shine.
When the stock market is down, an active investment approach can result in higher gains since there is more flexibility in this strategy compared to passive investing.
For clients who want lower charges with the option of being conservatively positioned owning a high-quality, basic portfolio, then passive may be more appropriate.
Then again, to become a better investor, you do not necessarily have to be a full-on active investor or wholeheartedly take a passive approach. Rather, sometimes it can often be wise to merge strategies from both approaches together.
Volatility Measurement
Volatility is a statistical measure of the dispersion of returns for a given investment and having a volatility measure, can prove a useful tool in matching your own risk profile to your chosen investments underlying assets and fund management style.
European Union (EU) law requires investment product provers to indicate a level of risk for each fund using a prescribed approach, which involves a volatility risk rating scale of 1-7.
This is known as the ESMA risk rating and is there to help investors compare similar funds offered by different providers.
As you move from 1 to 7, the potential for better returns increases but so too does the risk of losses, so as stated early, time horizon and investment purpose are key as to is an annual review of each and every investment held.
Pound Cost Averaging
People making regular contributions can afford to take the most risk with the highest exposure to equities as they can ride out the movements of the market over time, by buying during the lows. Lump sums, on the other hand, may benefit immediately from market rises but are more exposed to any downturns in terms of their recovery.
Simply put, pound cost averaging allows investors to benefit from market volatility over the long term by investing regularly because it allows them to buy units more cheaply on average!
Fund Manager Diversification
There is no doubt that there are many huge challenges facing both corporates and governments in terms of increased debt and an inevitable massive increase in employment, but there is also no doubt that certain sectors will thrive when others fail.
Stock prices tend to typically take the escalator up, but the elevator down and although many expect the elevator to be slow for the next 2 years, choosing the right fund manager whether investing in passive or active funds or both will play its own role in your financial fortunes.
Some fund managers will be more defensive than others, while some will place more value on high dividend-paying companies than value companies, the point being no single fund manager will always lead the way, so a mixture of fund manager styles can also be of benefit and should be discussed with your financial advisor.
These days an advisor needs to look much more closely at what each fund is offering and how the particular manager is approaching the task of managing client money, simply obtaining an ESMA risk rating and then matching it to a single fund manager is not nearly good enough.
Ongoing Financial Advice
I’ve spoken before about the risks of trying to time the markets, but that’s not to say with the help of your chosen financial advisor, that you can’t discuss market conditions and reassess your approach as your needs may change, in fact, a proper review should occur annually.
Remember your fund manager is there to manage your chosen investments and your financial advisor to help ensure its ongoing suitability.
Bottom Line
No one can predict if we have reached the bottom of the current cycle, or when we will start to see actual recovery. However, during times of economic uncertainty, it is important to remember that the principles of long-term investing remain unchanged and that short-term falls do not necessarily impact long-term goals. In fact, bull markets tend to last far longer and generate moves of far greater magnitude than bear markets.
Time after time, bear markets have proven to be good buying opportunities for long-term investors, time and patience can take advantage of current market opportunities albeit that we would at this point in time be broadly recommending a defensive and highly diversified approach as you return to equities.
Recession Investing Checklist:
- Define clear, measurable, and achievable investment goals.
- Base the level of volatility risk on the purpose behind the investment and it is time horizon.
- Diversify your portfolio albeit active or passive investment.
- Don’t think cash is the only alternative during a recession or high market turbulence.
- Continue to make regular contributions to your pension, whenever possible.
- Take time to understand passive and active investment strategies.
- Place more emphasis on charges, especially in a low risk, short term, or ARF investments.
- If investing in an ARF make sure that you’re clear on the long term effect of income drawdowns.
- Review your portfolio annually and rebalance it when necessary.
- Stay engaged with your financial advisor.
For more information
Contact: Ken O’Gorman – Director – QFA – Pensions & Investment Specialist – One Quote Financial Brokers on: 01 845 0049 or email: [email protected]
Initial telephone consultation is free with personal investment advice chargeable thereafter in accordance with our remuneration basis.