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Ride out a recession

Investors concerned about a US recession could move to a defensive position but a better bet in the long term would be a balanced portfolio which can ride out market conditions, says Will Henley

If the US goes into recession, how will your clients’ investments be affected and can you shield them from the effects of an economic downturn?.

The Organisation for Economic Co-operation and Development forecast in September that growth in the US could fall from 2.1 to 1.9 per cent this year.

The report did not take account of the most recent market volatility and said consumer resilience in the US will be tested by mortgage rate resets, tighter credit standards, weaker collateral and slower job creation.

Chief economist Jean-Philippe Cotis said: “Our diagnosis is a slowdown. We cannot rule out a recession.”

Fidelity special situations fund manager Anthony Bolton has warned there is a 50/50 chance of recession in the US. At a Morningstar conference in London recently, he said: “We can only see the ripples and no one knows what is underneath.”

Barclays Capital puts the likelihood of a recession at “perhaps one in three” compared with one in six in July. Chief investment officer Kevin Lecocq blames the change largely on”turgid credit conditions”.

He says: “Markets have caught a bit of a cold this summer with the troubles in sub-prime which then spilled over into structured credit and the whole asset-backed arena.”

The concern for advisers and investors is that if the US dips into recession, the UK will be hit by the knock-on effects.

AJS Wealth Management director Anna Sofat says: “The UK and Europe will not escape. Equities as a whole will suffer.”

AWD Chase de Vere investments manager Anna Bowes says equity income portfolios might look toward defensive stocks in the event of recession. “Foodstuffs, cigarettes and alcohol are all areas that stand up well,” she says.

But Hargreaves Lansdown head of research Mark Dampier says making macro forecasts is notoriously difficult. He says: “Recession is an emotive word. There are too many imponderables. You need to be clear whether you are talking about a couple of quarters without growth, a severe recession or a shallow one.

“The housing market troubles have only really affected the very poorest sections and they are not the main consumer spenders but if you seriously believe that there is going to be a recession in the US, your best option is to be in cash and bonds.”

Sofat says investors should look at gilts. She says: “Gilt prices have been falling over the past 18 months, with negative returns, but over the last month or so, some of that has come back. I would go for index-linked gilts myself.”

Lecocq says fixed-income investments do well in recessionary periods but adds: “In our estimation, they have already rallied a lot and probably do not offer tremendous value.”

He says index-linked gilts are one of the most expensive assets in the world because there is little supply of long-dated inflation-linked paper. “Yields with inflation gilts are not far from zero at the moment and they trade very expensively to a regular portfolio of high-quality industrial names,” he says.

The best strategy could be to create a balanced portfolio of assets that can withstand the effects of a recession over the long term.

Bowes recommends structured and multi-asset funds as a one-stop shop. She says: “You do not want to prepare your portfolio for one potential. If it does not pan out how you expect, that will be detrimental.”

Sofat says once asset allocation has been agreed with a client, there should be no need to make major investment alterations. “If one asset is on a downturn, another should be upcoming. I usually have 50 to 65 per cent in equities and focus on big companies with decent valuations and good dividend yields. Then, in an economic downturn, you are better cushioned,” she says.

Barclays Capital believes the US is likely to avoid recession but there will be “a fair amount of froth and turbulence in markets this autumn” although liquidity should come back.

As a caveat, Lecocq says: “It is difficult to say carte blanche what you should buy. If clients are nervous about recession, they should talk to their financial adviser about hedging strategies. It is individual as to how you want to manage your portfolio.”

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