How to prepare your investment portfolio for a recession? Embrace diversity

Dark economic clouds are gathering.

The war in Ukraine has helped push inflation to levels not seen in more than 40 years, and the response from central banks in the form of higher interest rates is weighing on growth.

The International Monetary Fund on July 26 warned that the world might soon be teetering on the edge of a global recession driven by slowdowns in the world’s three biggest economies: The US, China and Europe.

Two days later, data showed the US might already be in recession after its economy contracted for a second straight quarter in the three months through June.

The fallout for investors in the Middle East and North Africa is already evident. While Gulf stocks have been more resilient than many of its global peers this year, Middle East investors tend to keep much of their cash abroad and could be affected by the global downturn.

They are also big fans of digital assets. According to a survey published in April by online market research company Toluna, one-third of UAE residents have invested in cryptocurrencies.

Moreover, Emiratis plan to allocate 25 percent of their investments to cryptocurrencies, compared with a global average of 20 percent.

However, now might not be the time to bet the house on crypto. Despite a much-needed rally in July, bitcoin, the most traded crypto asset, has lost 65 percent after peaking at close to $70,000 in November.

Investing during periods of economic turmoil is not easy. Every downturn has its contours as sentiment swings, and returns become uneven and volatile. For instance, the global financial crisis and the pandemic were both characterized by strong rallies in highly rated government bonds even as equities crashed. At the same time, this year’s sell-off in stock has been accompanied by falling prices of Treasuries, gilts and European government bonds as central banks increase interest rates to get on top of accelerating inflation.

This year’s investing bright spots have included the Gulf’s lively initial public offering market.

While there are always some opportunities out there somewhere, spotting them in rough economic seas is challenging, and the name of the game during a downturn is usually wealth preservation, which in essence means diversification.

Creating a diverse portfolio spreads risk and ensures investors are not sunk by an unexpected lurch downward in a single stock or asset class. Of course, it does not mean offloading your whole crypto portfolio or not hanging onto a few favorite stocks. But it does mean ensuring your holdings are broad enough that you do not necessarily notice when a single company in your portfolio deteriorates significantly.

But building a truly diverse portfolio can be tricky. Most retail investors are used to equity markets, but stocks tend to be heavily correlated, so even a diversified equity portfolio is unlikely to prove much of a haven.

For a genuinely recession-resistant portfolio, you are probably going to need other assets that are not correlated with stocks, such as government and corporate debt, commodities, property, private equity and hedge funds.

Accessing alternative assets, though, is not straightforward and often not something that a retail broker offers. Moreover, understanding all these new asset classes can also feel like a full-time job.

The timing of a recession is never certain, but with suitable holdings, it is possible to enjoy the upside while it lasts while minimizing the fallout from the downturn.

The same is true on the way out. Bear markets can last anything from a few days to more than a year — the longest US bear market lasted 630 days from 1973-74. So being ready for when the market returns to growth is best achieved with a professional’s help.

• Francois R. Farjallah is head of the Middle East and Turkey, EFG Bank.