How to invest through turbulent markets – an HL fund manager’s view

Economic headwinds are building, and many forecasters predict recessions across the developed world.

The causes are clear. Rising bills put pressure on consumers’ spending power, even after any government support measures kick in.

Since inflation’s proving to be stubborn, central banks are likely to continue pushing interest rates higher as a result, causing a knock-on effect to the general population.

From an investor’s perspective, these are challenging times. It’s hard to dodge these risks entirely, but there are five steps investors can take to help shelter their portfolio and navigate around the recessionary rocks.

This article isn’t personal advice, if you’re not sure if an investment’s right for you, ask for financial advice. All investments, and any income they produce, can fall as well as rise in value, so you could get back less than you invest.

Become familiar with defensive shares

When bills begin to increase, the general public cuts back on what they don’t need and instead spends on what they need most.

Food and medicine are essential to everyone, we rely on them in our everyday lives. Companies in these sectors are known for their defensive nature. Because of the reliance we have on their products, the likelihood is they’ll not grow exponentially, but ebb and flow with the changing economy.

Medicine manufacturers have shown great pricing power over the long term and food brands have long navigated rising and ebbing inflationary trends. These businesses have a great ability to manage their top and bottom lines over the long run.

Supermarkets rarely allow the producers of their own-label lines to make high margins (profits). But brand owners are the only place retailers can go to get the names consumers look for on the shelf. That means they have more strength when it comes to negotiating their pricing.

This doesn’t mean your whole portfolio should be made up of defensive shares, but they’re a potential line of defence when markets slide.

Beware of big spenders

Some products require enormous industrial structures to be built, before finished products can start rolling off the production line. Think car factories, or semiconductor foundries.

For these industries to operate, vast amounts of money needs to be spent, and those assets will likely need lots of ongoing spending to keep them working. That means constant pressure to generate cash just to maintain the status quo. When economies take a turn for the worst, things can get ugly.

Businesses that sell intellectual property, like data, often have no need for these big production facilities. As a result, they can generate free cash flow far more predictably – this shows what’s left over from operating cash after expansion and upkeep costs. This can prove invaluable through an economic downturn.

Don’t try and predict mergers and acquisitions

Financially strong businesses can find that recessions are the equivalent of a closing down sale. Whereby weaker rivals can become acquisition targets and those with cash in the bank can fast-forward their growth.

The weakness of the pound in recent months could show potential for overseas buyers looking to the UK industry in search of ‘bargains’. It’s difficult to predict whether a weaker company is sat on the horizon of a takeover, and you could risk seeing your investments unable to survive the economic downturn.

Rather than trying to pick smaller companies with a weaker balance sheet, hold onto the strongest player who will have the pick of the bargains.

Don’t let your portfolio be dragged down by debt

Debts are especially risky when there’s a recession. Unless a company has fixed its interest rates, then its debt will cost more to service. If profits are falling at the same time, then crises can occur.

Last year, interest rates were rock bottom, and borrowing was easy. But things look very different now.

Make sure to keep a look out for companies with high borrowings. Unless their revenues are more ‘secure’, there’s a risk that the debts could become unmanageable.

It’s well worth checking out how indebted the companies you have invested into are. Look at how their profits have fared in past downturns, especially ones where interest rates were rising.

When looking at your portfolio, check if there’s anything there that was dependent upon, or supported by the availability of cheap credit.

People and businesses tend to want less credit when it costs more. Activities like speculation on commodities becomes less attractive if more has to be spent to get where they want to be. The flip side of that is prices often fall.

Diversification is the best tool moving forward

For a portfolio to cope well in tough economic times, it’s vital that it’s well diversified. That way no single event can blow it badly off course.

And if you’ve also checked to make sure the investments you hold are built to withstand the hard times, as well as the good, you should be in a good place.

Being invested for the long term is key to creating lasting wealth. Trying to time market turns is very difficult and usually only leads to trouble.

So, stay invested, but try to armour-plate your portfolio as best as you can.

Are you diversified enough?

Steve Clayton is a Fund Manager of the HL Select range of funds.

Find out more about HL Select

The HL Select fund range is managed by our sister company Hargreaves Lansdown Fund Managers.

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