China's cooling economy, the on-going Brexit saga and the looming increase of interest rates in the United States of America ("US"), have all contributed to increasing global uncertainties. On the back of these conditions, Singapore recently narrowed its upper limit of the country's 2016 GDP growth forecast after marginally missing its second quarter growth estimates1.
While Singapore's not in a recession, there's no doubt that these factors have stunted economic activity and expansion plans in the country. The FTSE Straits Times Index ("STI"), regarded as the benchmark index for the Singapore stock market, tracks the performance of the top 30 stocks listed on the Singapore exchange. This has declined approximately 10% and 14% in the past 12 months and 24 months respectively2.
Of course, with every prolonged retreat in stock prices, comes along numerous market commentators jumping on the recession bandwagon.
Ideally, you want to invest for the long term and not constantly worry about another global crisis and be kept awake every night. To do this, you need to work towards limiting your risks and trying to create, as much as possible, a recession proof portfolio that will keep your mind at ease in any economic cycle.
Here, we highlight 5 possible ways you can mitigate the full effects of a recession on your portfolio.
The most obvious way to reduce the riskiness of your portfolio is to diversify your holdings. The age-old advice cannot be truer; don't put all your eggs in one basket, even if you believe that it’s a safe and strong basket. By diversifying your basket, your investments should not give you the kind of returns you tend to read about in the news – good or bad. This is because both your upside and downside are limited to near-market levels.
Unlike investing in specific countries, industries, or companies, diversification allows you to invest in a broader market spectrum. This means your returns will not be solely reliant on the performance of a specific region, a specific industry or a specific company. Even though this could lead to you feeling hard done by when you're right and not fully rewarded, you have to consider the converse: you're also not fully punished when you're wrong.
During downturns, certain industries can be hit harder than others. This is because certain sectors could have been the reason for propelling the economy into recession in the first place.
If you thought Keppel Corporation, being a world leader in the offshore and marine sector, was a strong bet in August 2014, you wouldn't have been wrong, but that wouldn't have stopped you from sitting on losses of more than half your investment today. If you had decided to instead diversify your holdings and bought the STI ETF, holding a weighted average of the top 30 stocks in the Singapore exchange, you would be sitting on losses of 17% instead of 51%3.
On the flipside, if you thought Ascendas Reit, which owns over 130 properties in Singapore, Australia and China and worth close to S$10 billion, was a strong bet in August 2014, you also wouldn't have been wrong, but today, you would be sitting on a 9% gain4 rather than 17% of losses if you had bought the STI ETF.
Not many people would be able to constantly pick the right stocks that outperform the markets, and even fewer would be able to pick stocks that beat the general market in times of recession. Going with a well-diversified portfolio, such as country indexes including the STI ETF, will give you the peace of mind that your portfolio is shielded as well as it could be.
2. Understand the risks in Emerging Markets
While embarking on a diversification strategy, people may look to invest in emerging markets. With rapidly developing and expanding economies, emerging markets may offer better potential for large gains in times of global economic growth but investors have to understand the risks associated with such markets as they generally face more risks and economic uncertainties.
The effects of a recession will be felt to greater extents in emerging markets because such economies rely heavily on trade and external investments that are abundant in times of confidence and economic expansion, and far less accessible in downturns. Due to this, companies in emerging markets face much higher volatility in earnings than companies in mature markets.
Typically, a recession will see demand waning on the global stage, adversely affecting export-driven economies, such as Asia, in particular China, India, Vietnam, Thailand, Indonesia, the Philippines and Malaysia, as well as commodities-rich markets such Indonesia and Malaysia in neighbouring South East Asian markets, and most of Latin America.
Besides understanding the risks involved in emerging markets, you will be able to reduce your portfolio risk by avoiding economies where corruption scandals could pose a potential problem for sound long-term investments.
3. Market cycles
Similar to sectors that you should pay closer attention to during recessions, there are sectors you should be cautious of because of their potential performance in recessions. Don't get us wrong, we're not saying these sectors make lousy investments, however, we're saying that when recessions hit, these sectors are likely to be hit the hardest.
The sectors most affected during recessions include materials, energy, industrial and information technology and consumer discretionary. These industries are either heavily reliant on government expansionary policies or are cyclical in nature. They're most at risk of delivering poor results that fall short of market expectations.
The reason for this is that sectors such as materials, energy and industrial are important drivers in the economy when they're expanding – more resources, including energy and metals, are required and more goods are manufactured. The same also holds true in recessionary phases where these industries would see reduced demand. A case in point is China's decelerating economy which has seen many commodity industries suffering after years of expansion in the 1990s to mid-2010s.
The information technology industry has itself seen peaks and troughs. The last time the industry saw a disaster was during the Dot-Com Crash in the early 2000s where majority of technology companies saw their share price soar on hopes for future profits which never came. Looking forward, we can safely say that no one really knows when the next down cycle will emerge, especially on the back of Uber's reported S$1.65 billion loss and Apple's soaring profits recently.
During recessions or industry down cycles, people and markets are even more jittery over companies' financial performances. Negative results by companies could spark a “run” on the company as people seek more predictable returns and safer havens.
4. Investing in defensive companies
The food and beverage (F&B)5, consumer staples6, and healthcare sectors typically deliver modest returns when economies are in full swing, yet appear most resilient during recessions since consumption levels are less affected by economic conditions in these sectors.
For example, stocks such as Sheng Siong and Thai Beverage in the consumer staples and F&B sectors are good examples that have performed well. In regards to the healthcare sector, it will continue to be shielded by Singapore’s reputation as a trusted healthcare services destination, as well as being able to tap on the increase in demand from the country’s rapidly ageing population.
When selecting companies in these sectors, we should bear in mind that companies with longer histories of consistent performances are generally more favourable as they have demonstrated the ability to weather storms and take advantage of economic upswings.
5. Other asset classes – Fixed Income or even Government Bonds & CPF SA
Other asset classes offer even more diversification for investment portfolios. Fixed income securities, generally, bonds also offer another investment alternative. Bonds represent an obligation for the issuers to pay the promised interest rates or coupon payments.
The downside is that many bonds are not accessible to the retail investor. For example, most bonds are sold in denominations of $250,000, including those issued by commodity firms Olam and Keppel Corporation. Olam has issued various bonds in the past paying coupons from 4.25% to 7.0%; while Keppel Corporation has issued bonds paying 3.1% to 4.0%. In contrast, Ascendas Reit, a diversified real estate play, has issued bonds at 2.5% to 4.75% only. You should also note that you're able to invest in government bonds through bond ETFs such as Nikko AM's ABF Singapore Bond Index Funds. This bond fund invests in triple A-rated Singapore government bonds and has a track record for delivering an annualised return of 2.23% for the last five years.
In recent years, companies such as Hyflux, Aspial and Oxley have issued bonds in denominations of $1,000, giving retail investors the opportunity to invest in this asset class. These tend to be riskier as these companies are smaller and may not have the financial might of larger issuers when recessions hit7.
In Singapore, we're also able to put money in Singapore Savings Bonds, which gives returns of 1.75% per annum if held for a 10-year period, which is the maximum term we can hold these bonds for. These bonds offer liquidity to investors while delivering better returns than savings accounts. They could also act as ammunition in times of market downturns for us to buy valuable stocks in the market.
Another area Singaporeans can consider putting money in is the Central Providend Fund (CPF) SA (Special Account). In this method, investors' monies are tied up over the long term but are able to fetch over 4% in yearly returns8.
All investments fluctuate with time
When all's said and done, it's important to note that all investments fluctuate with time, and your objective should be to keep your risks in line with what your financial portfolio is able to withstand. You need to bear in mind that high returns usually equate to higher risks, and past performance is not an indication of future performance.
By " recession proofing " your portfolio, you hope that you can sleep better. However, at times, the financial markets will be subjected to volatility regardless of economic conditions. Even the best portfolios may fluctuate up and down, but you should maintain your long-term strategy and objectives. You should conduct a yearly review of your portfolio to ensure that it’s still in line with your strategies. You could also consider seeking advice from a licensed financial adviser on your investment matters.
1 Straits Times – 11 August 2016 – Govt lowers upper limit of Singapore's 2016 growth forecast to 2%
2 ShareInvestor – As at 1 August 2014, 2015 and 2016, the STI was trading at $3,344, $3,202 and $2,892 respectively.
3 ShareInvestor – As at 1 August 2014, the STI ETF was trading at S$3.38. In the same period, Keppel Corporation was trading at $10.8
4 As at 1 August 2016, the STI ETF was trading at S$2.89 while Keppel Corporation was trading at S$5.30. This represents a loss of 17% and 51% for the STI ETF and Keppel Corporation respectively. These returns do not take into consideration any dividends paid out.4 ShareInvestor – As at 1 August 2014, Ascendas Reit was trading at S$2.308, and as at 1 August 2016, it was trading at S$2.520. This represents a gain of 9%. This does not take into consideration any dividends paid out.
5 SGX My Gateway Report – 30 August 2016 (Strongest Food and Beverage Stock in 2016 YTD) reported that the 10 largest F&B stocks in the Singapore stock market averaged a 23% gain in YTD to 26 August 2016. It also reported that the sector plays a large role in Singapore’s economy and the stock market. Thai Beverage, listed as one of the 10 largest F&B stocks on the Singapore exchange, delivered a 48% during this period.
6 SGX My Gateway Report – 30 August 2016 (Latest highlights of Singapore’s consumer sectors) reported that over the first seven months of 2016, consumer staples generated a market capitalization weighted total return of 23%, the highest of any sector or key industries in Singapore. Sheng Siong was listed as holding “much relevance to everyday trips to the supermarket” in Singapore.
7 Straits Times – 22 August 2016 – Choppy bond market raises questions
8 CPF.gov.sg – 4% floor interest rate for Special Account extended to 31 December 2016