Investing During a Recession

Global supply chain difficulties, an energy crisis, the rising cost of living and the removal of government coronavirus support schemes have all taken their toll on businesses.

As discussed in our Q2 Intelligence Report, the UK economy performed worse than most analysts expected during Q1 2022 and even declined by 0.3% during April 2022.

Inflation is expected to reach 11% later in the year and interest rates have increased five times in recent months. 

As a result, many financial analysts are predicting that the UK will enter a recession in 2022. 

Speaking to the BBC, Danny Blanchflower, a former member of the Bank of England’s Monetary Policy Committee, said that the UK is probably already in recession and other major economies around the world are likely to follow suit.

This presents companies with a difficult decision: should they continue to invest during the recession or cut back on spending to protect their business?

Many companies have already started doing the latter. Business investment fell by 0.5% in Q1 2022. This means investment is significantly lower than it was before the pandemic.

An economic downturn is challenging for investment companies and businesses that need funding. The number of company insolvencies usually increases during these periods. This makes investing more risky than usual.

This article lists some techniques that will help you make wise investment decisions during the recession and create a portfolio that can withstand the economic turbulence.

What Is a Recession?

A recession is when the economy contracts for two consecutive quarters. Whether the economy has grown or contracted is measured using gross domestic product (GDP). 

However, a recession is only a technical term. The economy could contract for two non-consecutive quarters during a year. This is known as an economic downturn and it could still be a difficult time for people and businesses.

Should I Still Invest in a Recession?

Whether your business continues investing during a recession depends on your specific circumstances. Some things to consider include:

• How much risk are you willing to tolerate? 
• Are your company’s finances being affected by the recession? 
• If so, is it better to keep your cash in the bank?

In some ways, a recession presents excellent opportunities. Some companies will decline in value, meaning that you can buy stocks in them at a reduced price. Others will be undervalued. 

If you buy shares in these companies and the economy begins to recover, their stock market value could increase and you would reap the rewards.

But this is a risky strategy. Company stock values usually decline for a reason. Businesses in financial distress could be more likely to go insolvent during a recession.

Not every company is stalling or in decline though. Our growth score has shown 

there are great companies across the country still achieving double-digit growth figures.

Therefore, a better strategy for risk-averse investors or those with little capital to play with might be to find companies with a good business model and robust finances. These companies are well-positioned to survive difficult times and present a less risky investment.

Recession-Proof Investment Strategies

Here are some of the ways you can identify companies with a greater chance of surviving the recession and providing you with sustainable returns. Use them in your investment strategy to help reduce portfolio volatility.

Invest in Attractive Sectors

Certain industries are particularly vulnerable to economic difficulties. A good example of this is construction. In recent months, the sector has seen a growing number of companies file for insolvency and production levels have dropped. On the other hand, sectors like food, FMCG and textiles are likely to stay steady.  

Before you invest in a sector, check how many insolvencies it is experiencing or how many companies are in financial distress. 

You can find this information on the UK Insolvency Service website or you can use our insolvency risk score—we give healthy businesses gold, silver and bronze ratings, while companies at risk of insolvency are rated one, two and three red flags. You can view this data by sector and geographic area, giving you a clear picture of a recession’s impact across the economy.

If these numbers are increasing then the sector is probably high risk. Note that there will likely be regional differences within each sector. 

Invest in Financially Healthy Companies

Before you invest, always check a company’s finances. Try to find high-quality companies with strong balance sheets. There are a number of warning signs that indicate a company could be in financial difficulties and therefore be a poor investment. These include:

• Highly leveraged (high debt-to-equity ratio) 
• Directors hold fixed charges over company assets
• The company has experienced bad debt
• Overdue accounts or a change in a filing period
• CCJs
• Undervalued assets
• Poor liquidity
• Low margins

Diversify Your Portfolio

The more companies in different sectors that you invest in, the less portfolio risk you have. Therefore, it could be worth spreading your investments more widely.  

If you have particular expertise investing in a specific sector then it could be a good option to spread into a similar industry. 

For example, if you normally invest in residential real estate developments you may be able to transfer some of that knowledge and invest in commercial real estate.  

The downside to this is that adjacent industries can also be impacted by a recession.

To avoid this, you could look at entirely different sectors. But you should do a lot of research first. 

Heighten Your Due Diligence

Recessions are hard enough without getting a fine for failing to meet regulatory requirements, or losing a customer because they have been subject to sanctions.

It is illegal to work with companies where a person with significant control is on an international sanctions list. 

The war in Ukraine and the resurgence of the Taliban in Afghanistan mean that the number of people on these lists has increased dramatically. 

It’s therefore vital to have robust AML systems and procedures to ensure that the companies you invest in are not involved in fraud or money laundering.

Identify High Growth Companies 

The best way to protect your portfolio from the recession—and increase its value during a bull market—is to invest in companies with high levels of growth.

Of course that’s what all investors aim to do, but identifying which companies are most likely to grow is very difficult. 

Some investors choose to measure the amount of venture capital that a company takes on.

But this disregards businesses that grow organically. It also doesn't necessarily equate to high growth—a well-financed, but poorly managed company may grow slowly or perhaps not at all.

That’s why we’ve come up with a solution to help investors identify high-growth companies. 

Beat Economic Downturns with Red Flag Alert

Our growth propensity score accurately tells you precisely which UK companies are likely to grow. 

You’ll also get precise data on: 

• Where they are based
• What sector they work in
• Each company’s financial health
• Who the company directors are and how you can contact them

Investors like you can use the score to check the growth potential of companies and approach them for investment. You can also use it to monitor the growth of businesses you already fund.  

This helps you to manage your portfolio better to survive the recession.

Find Out More 

Red Flag Alert provides and enriches data on every UK business. We help you find opportunities, reduce financial risk and stay compliant with regulations. Book a free demo to find out more.