Threat of recession taints cyclicals’ appeal

The investment dilemma that has plagued us for the last five years means investors have stayed away from lesser-known indices and markets and taken comfort by staying in familiar territory.

Whether we slip back into recession or not, growth will be anaemic at best. Rather than look where we can go to achieve a return on our capital, it is easier to suggest what to avoid.

It would appear wise to avoid investing in businesses that rely on a strong economy – so-called cyclical businesses such as retailers and housebuilders.

There are still few compelling reasons to back the banking sector at this stage. Balance sheets are opaque – the extent of exposure to bad debt is still unclear – and the regulatory environment is uncertain. If the economic situation turns out better than expected, or the eurozone crisis is resolved, banks could see a sharp relief rally in their share prices. However, this is highly uncertain, especially in the short-term, and as such banks appear a high risk/high return proposition.

In particular the UK has proved to be more robust than worldwide economies and investors are using us to shelter from the bad news affecting other markets.

We may see the traditional rush of end-of-year ISAs diluted by investor sentiment, however those that have regularly invested in ISAs in the past are not deterred and have continued to put money into markets, recognising long-term benefits.

In general, we have seen investors prefer the consistency of core holdings in portfolios rather than jump on the latest bandwagon. It is reassuring that investors recognise this and understand the need for diversification in all asset classes.

Unless you believe all the evidence is wrong and expect the UK to enjoy a strong cyclical recovery, the most sensible policy seems to be to concentrate on defensive businesses. These are companies that are able to survive and even thrive in bad economic conditions. They tend to supply goods and services that people find hard to cut back on even if incomes are squeezed – prime examples include the pharmaceuticals, utilities and telecommunication sectors. Many pay attractive dividends to investors and have large amounts of cash on their balance sheets.

Looking for equity income funds is an excellent way to encompass such a strategy. This sector has certainly shown positive progress, suffering from less volatility than its peers. Where reliance will be heavily biased towards dividend returns, these funds provide a fundamental underpin to achieving that growth potential in the next 12 months.

While it is human nature to look at the supposed safe-havens of cash or property in the long-term, equities cannot be ignored and this is where the skills of stock-pickers have proved favourable. Funds in the IMA UK Equity Income sector are where both short- and long-term value can be achieved.

This is where the strong expertise of the manager and team is essential in understanding a particular market. Such funds complement a well-diversified portfolio.

No one can demonstrate this more than Invesco Perpetual’s Neil Woodford, and in particular his income fund.

While this is a highly competitive sector, Woodford stands head and shoulders above the crowd.

Kerry Nelson is managing director of Nexus IFA. The views expressed here are her own.