If you've been reading my weekly and monthly newsletters you will be aware that recession fears have risen sharply in the last month. Investment markets have reacted accordingly, with bond yields falling alongside commodity prices. We've also seen some rotation within equity markets, where money has flowed out of company shares in certain economic sectors into others in the hope that they may fare better in a recessionary environment.
It raises the question of how should you invest for an impending recession?
How to invest for a recession
The first and most obvious asset class that should in theory benefit from the market pricing in a recession is bonds. If economies around the globe begin to contract, central banks will cease their monetary tightening plans and possibly begin loosening policy again. That would mean that they stop increasing interest rates and instead start to reduce them to avoid a severe recession. This in turn would inevitably make the fixed income generated by bonds more attractive causing yields to fall and bond prices to rise.
So it would be worth looking at my recent research piece Funds for a bond market rebound for bond fund ideas.
Elsewhere, in a recession commodities are likely to fare badly as demand is closely linked to economic growth. See my newsletter Call the Dr... the economy looks sick.
But what about equities? Corporate profits are usually closely linked to economic growth so a potential drop in profits should in theory make equities less appealing. However, different equity sectors fare better or worse than others during each phase of the economic cycle. During a period of rapid expansion cyclical stocks tend to fare better as we saw during the post-pandemic economic recovery. Conversely during periods of economic contraction cyclical sectors tend to lag defensive sectors.
Below is a list of the sectors that cover the companies within the S&P 500. Most global stock markets have similar sector make-ups.
- Communication services
- Consumer discretionary
- Consumer staples
- Energy
- Financials
- Health care
- Industrials
- Information technology
- Materials
- Real estate
- Utilities
Those sectors highlighted in red are widely regarded as defensive sectors while those in green tend to be cyclical. So if you want to invest in equities for a recession then you might prefer to invest in companies from the Health Care, Utilities or Consumer Staples sectors.
This makes sense because in times of recession consumers and companies pare back unnecessary spending. But during a recession consumers will still spend money on food, drink, tobacco and certain household items such as cleaning products. Companies that sell these products are categorised as being in the Consumer Staples sector. During a recession consumers still need medicines (sold by companies in the Health Care sector) as well as water and electricity (provided by Utility companies).
But this likely outperformance of defensive sectors goes beyond just theory. Fidelity International produced the chart below following research into how different equity sectors have tended to perform across past economic cycles in history (click image to expand).
The sectors coloured green tend to outperform during the stated part of the economic cycle and the scale of that outperformance is represented by the + and ++, with the latter representing the strongest outperformance. Conversely the red sectors have underperformed during the stated economic cycles, with those marked -- underperforming the most.
Right now it is likely that we are somewhere between the late cycle and possibly the recessionary cycle on the right of the chart. If you look at the sectors that tend to outperform during both of these periods then it is utilities, health care and consumer staples that lead the way.
Funds with defensive equity exposure
So as an investor you might decide to rotate your equity exposure within your portfolio towards those three key sectors. Now this is relatively straightforward with ETFs, as there are a host of them that track the performance of individual sectors, particularly in the US. You can simply search the sector names within your platform's ETF search function.
But if your platform doesn't offer them, or you don't want to take such a direct and significant bet on the economic cycle you could instead opt for a diversified equity fund that has higher exposure, than its peers, to utilities, health care and consumer staples. However it's not easy to screen for funds with higher than average exposure to these sectors using tools available on mainstream platforms or research sites such as morningstar.
So I have analysed over 1,700 unit trust and investment trusts to produce a shortlist of funds that have significant exposure to utilities, health care and consumer staples sectors.
The criteria that each fund had to meet were:
- at least 5% exposure to each of the three defensive sectors (utilities, health care and consumer staples)
- at least approximately 30% total exposure across all three defensive sectors
This produced the two lists below. You may need to scroll to the right on each table to see the final columns.
However, there is no guarantee that the funds selected will necessarily outperform if a recession hits. It is also worth bearing in mind that no two recessions are quite the same. For example, right now we have an overlay of surging energy prices and by way of example, there was no such surge in the pandemic-induced recession of 2022. So to give an overlay of the current market environment to the tables I have highlighted in green the funds that outperformed the average of their peers during two recent bouts of recession fear which coincided with a drop in the 10 year US treasury yield as shown by the red arrow in the chart below. The two periods were 14th-23rd June and 21st-23rd June, when there were two aggressive sell-offs as recession fears gripped markets.
Unit trusts for a recession
| Fund | ISIN | Sector | Health Care % exposure | Consumer Staples % exposure | Utilities exposure % | Total defensive exposure % |
| ASI European Equity Enhanced Index | GB00BGHW1T66 | Europe Excluding UK | 18.18 | 10.4 | 5.04 | 33.62 |
| Aviva Inv Continental European Equity | GB0004457973 | Europe Excluding UK | 18.52 | 10.52 | 5.69 | 34.73 |
| BlackRock Continental European Income | GB00B3S9LG25 | Europe Excluding UK | 19.34 | 5.13 | 7.02 | 31.49 |
| Fidelity Sustainable European Equity | GB00B8287518 | Europe Excluding UK | 17.7 | 9.7 | 5.5 | 32.9 |
| Jupiter Merian European Equity (ex UK) | GB00B1XG8D08 | Europe Excluding UK | 19.5 | 8.4 | 9 | 36.9 |
| AXA Framlington Global Thematics | GB00BRJZVP64 | Global | 20.57 | 5.65 | 7.09 | 33.31 |
| JOHCM Global Opportunities | GB00BJ5JMC04 | Global | 14.68 | 7.96 | 13.3 | 35.94 |
| FP Carmignac Emerging Discovery | GB00BJHPHX25 | Global Emerging Markets | 9.29 | 11.05 | 11.53 | 31.87 |
| BNY Mellon Global Income | GB00B7XK5M25 | Global Equity Income | 16.88 | 11.74 | 7.07 | 35.69 |
| Fidelity Global Dividend | GB00B7778087 | Global Equity Income | 14.7 | 13.2 | 6.4 | 34.3 |
| Sarasin Global Dividend | GB00BGDF8F44 | Global Equity Income | 17.1 | 8.4 | 5.7 | 31.2 |
| Sarasin Global Higher Dividend | GB00B84ZSV39 | Global Equity Income | 17.6 | 9.8 | 6.3 | 33.7 |
| Aviva Inv US Equity Income | GB00B44GRT93 | North America | 13.65 | 11.65 | 11.28 | 36.58 |
| T. Rowe Price US Equity | GB00BD8G5832 | North America | 20.06 | 9.82 | 5.25 | 35.13 |
| T. Rowe Price US Large Cap Value Equity | GB00BD446M25 | North America | 20.19 | 8.6 | 8.74 | 37.53 |
| VT Tyndall North American | GB00BYPZY050 | North America | 27.19 | 13.58 | 9.33 | 50.1 |
| FTF Franklin UK Opportunities | GB00B76GK996 | UK All Companies | 12.67 | 21.58 | 5.08 | 39.33 |
| Invesco Income & Growth (UK) | GB00B3RS9443 | UK All Companies | 7.12 | 8.12 | 14.91 | 30.15 |
| Invesco Sustainable UK Companies (UK) | GB0033031047 | UK All Companies | 8.37 | 15.29 | 15.78 | 39.44 |
| Invesco UK Equity High Income (UK) | GB00B1W7HH10 | UK All Companies | 6.82 | 12.25 | 13.78 | 32.85 |
| Jupiter Responsible Income | GB0008337569 | UK All Companies | 14.5 | 14.7 | 19.3 | 48.5 |
| Schroder Sustainable UK Equity | GB0032312729 | UK All Companies | 15.66 | 10.13 | 11.54 | 37.33 |
| Scottish Widows Environmental Investor | GB0031632010 | UK All Companies | 11.6 | 13.96 | 9.9 | 35.46 |
| Scottish Widows Ethical | GB0032200213 | UK All Companies | 18.1 | 10.01 | 11.26 | 39.37 |
| VT Vanneck Equity | GB00BJ4G2665 | UK All Companies | 10.63 | 19.33 | 5.29 | 35.25 |
| BMO UK Equity Income | GB0033146340 | UK Equity Income | 14 | 15.8 | 5.3 | 35.1 |
| ES R&M UK Equity Income | GB00B3KQG447 | UK Equity Income | 16.79 | 21.65 | 5.43 | 43.87 |
| Fidelity Enhanced Income | GB00B87HPZ94 | UK Equity Income | 9.5 | 22.4 | 9.2 | 41.1 |
| Fidelity Moneybuilder Dividend | GB00B3LNGT95 | UK Equity Income | 11.2 | 24.4 | 10.5 | 46.1 |
| Premier Miton Income | GB0003884722 | UK Equity Income | 11.5 | 14.1 | 6.1 | 31.7 |
| Premier Miton Monthly Income | GB0003886875 | UK Equity Income | 11.6 | 14.2 | 6.1 | 31.9 |
| Premier Miton Optimum Income | GB00B3DDDX03 | UK Equity Income | 11.7 | 15.3 | 6.1 | 33.1 |
| Threadneedle UK Equity Alpha Income | GB00B12WJY78 | UK Equity Income | 16.2 | 15.5 | 5.04 | 36.74 |
Investment trusts for a recession
| Fund | ISIN | Sector | CITI | Health Care % exposure | Consumer Staples % exposure | Utilities exposure % | Total defensive exposure % |
| Aberdeen Standard Fund Managers Ltd - Dunedin Income Growth Investment Trust PLC | GB0003406096 | IT UK Equity Income | DU37 | 10.1 | 5.4 | 13.8 | 29.3 |
| Aberdeen Standard Fund Managers Ltd - Murray Income Trust PLC | GB0006111123 | IT UK Equity Income | A783 | 11.7 | 7.8 | 12.4 | 31.9 |
| Allianz - Merchants Trust PLC | GB0005800072 | IT UK Equity Income | BJ25 | 15.9 | 7 | 6.4 | 29.3 |
| BlackRock Investment Management (UK) Ltd - BlackRock Sustainable American Income Tru | GB00B7W0XJ61 | IT North America | GWOO | 5.1 | 5.1 | 19.5 | 29.7 |
| Invesco - UK Equity Share Portfolio | GB00B1DPVL60 | IT UK Equity Income | J689 | 6.1 | 13.9 | 6.3 | 26.3 |
| Janus Henderson - Henderson High Income Trust | GB0009580571 | IT UK Equity & Bond Income | HE23 | 25.17 | 7.86 | 7.31 | 40.34 |
| Janus Henderson - The City of London Investment Trust | GB0001990497 | IT UK Equity Income | HJ01 | 20.99 | 7.37 | 9.58 | 37.94 |
| Schroder Investment Management Ltd - Schroder Income Growth | GB0007915860 | IT UK Equity Income | QA24 | 5.8 | 7.1 | 16.4 | 29.3 |
Final thoughts
Aside from investing in bonds and defensive sectors one strategy is to invest in companies that pay reliable dividends. Defensive sectors tend to be among those companies that do provide reliable dividends. It is therefore no coincidence that the shortlist of funds above have a disproportionate number from equity income sectors. Or in other words funds that aim to produce reliable income payouts over time. During a recession, you want to focus on those that have a history of maintaining and growing their payouts over time. That is precisely what our UK income fund heatmap, Global income fund heatmap and Investment trust income heatmap do and it is, therefore, no surprise that the likes of Janus Henderson The City of London Investment Trust , which has grown its dividend payout for the last 55 years in a row, makes the list above.
