Consultants’ Corner: How would a UK recession affect your investments?

As with all investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest. If you are unsure investing is the right choice for you, please seek financial advice.

As investment consultants we have a lot of conversations about the effects on portfolios should the UK go into a recession. Here’s our response:

After a few conversations I’ve had with clients, talking about the possible effects on portfolio performance if a recession were to happen in the UK, I felt compelled to write a piece that explains some of our views. 

The UK is currently losing the race on controlling inflation – which is number one on the priority list for central banks globally. We have seen a good proportion of the world raising interest rates to manage the out of control cost of living, and data suggests that the UK, compared to its peers, has been able to do this less effectively. Whilst CPI inflation  (the most widely used indicator of effectiveness of government economic policy) is reading at a 2.9% rise in Europe, 3.69% in the US, while in the UK it’s at 6.7%. 

This means that, whilst these figures remain persistent, central banks are unlikely to lower interest rates, to make sure they can manage to get inflation fully under control. The Monetary Policy Committee (MPC) has once again kept interest rates to 5.25% and have given no indication of this coming down in the coming months.  This may start to have a meaningful impact on consumers and businesses.

At Moneyfarm, we diversify our portfolios globally through three main areas: bonds, equities and currencies. Therefore, looking at the impact of an isolated UK recession – being that the recession is UK specific and not a wider contagion problem affecting the world economy – what would this mean for each of these areas specifically?

Equities

• As the economy weakens, this will often deter investors from investing in their home country and therefore will affect equity performance here in the UK. However we don’t hold a lot of UK equities and we certainly don’t hold any small cap equities. Therefore we haven’t got a big risk exposure to any negative impact of a more localised UK recession on our equity weighting.
• The FTSE 100 is a different story, with around 70% of business conducted overseas – which means that when the economy weakens, this is in fact positive as we would expect a devaluation of the home currency overseas and investments would become more favourable.
• Diversification into different countries is something that we do in any case to spread risk, but also as markets are priced conservatively there are good buying opportunities, especially if looking for the long term.

Currency

• Central bank actions: The BoE may respond to the economic downturn by implementing monetary policy measures, such as interest rate cuts or quantitative easing. These measures can influence the currency, as lower interest rates can reduce the attractiveness of the local currency for investors, this in turn will mean that GBP will fall and overseas currency will become more attractive, when converted.
• Capital flight: During a regional recession, investors may seek safer and more stable investment opportunities elsewhere. This can lead to capital flight from the UK, putting further downward pressure on the local currency. As investors move their funds out of the UK, they will look to convert GBP into other, more stable currencies, contributing to the depreciation of the GBP.

To summarise, our portfolios tend to benefit when GBP value falls. An investment in a stronger and more stable economy will look more attractive when converting it back to a more unstable and devalued sterling. 

Bonds

• Bonds are seen as a safe haven when the economy weakens.
• Currently inflation is persistent, therefore interest rates remain high, which is not positive for bonds; bond prices remain low, which is a good buying opportunity.
• If the UK were to go into recession, this would mean that interest rates are likely to fall which is positive for bonds. Bonds prices have an inverse relationship with interest rates. 
• For example, imagine you buy a £100 government bond that pays you a fixed 3% coupon every year. Interest rates then fall, and newly issued government bonds only offer a 2% coupon. You still have the government bond you bought for £100 that pays you 3% interest every year. Demand for your government bond rises, taking the price you can sell it for with it. 

Simply put, you’d expect bonds to do well if the UK economy weakens. However, the bond market is complex and different types of bonds are affected in different ways. If you have any more specific questions, or would like more information, please get in touch by booking a meeting through the website.

In summary 

At Moneyfarm, we firmly believe that global diversification is an effective and efficient way to manage risk in portfolios. 

Investing in UK assets radically increases your exposure to UK risks. It’s highly likely that you already have a large home country bias – you probably work in the UK, own a property in the UK, or you might even have started a UK business. If so, the majority of your assets and income are closely tied to the UK economy. 

By spreading your investments across different geographies, you can reduce your exposure to one economy. Then, if the UK struggles over the short-term, you can hope to offset any weakness with gains made in other regions of the world and benefit from foreign exchange movements. 

When you diversify your exposure globally, it’s also less likely that you will feel compelled to make rash, knee-jerk reactions to short-term events, instead sticking to your long-term strategy.

If you know what’s going to happen, should you trade to protect the value of your investments? The problem here is timing; no one knows exactly when moves are going to happen and they often happen very quickly – if managing your investments is not your full-time job, you could miss crucial opportunities. 

If you adopt this approach, you need to be right twice. You need to both sell at the right price (high) and buy back at the right price (low).

These are notoriously difficult decisions to get right, and not just because it takes a lot of time, skill and experience to identify these opportunities correctly.

If you have any questions about your investments you hold with us, you can always get in touch with your investment consultant who would be happy to run you through the investments and make sure you’re on track for your financial goals. 

You can call us at any time for a free consultation or simply book an appointment here. Our team is always on hand to help you with any questions or queries you may have about your investments and the best ways to help manage your money.

Tim Baudouin: Timothy is an Investment Adviser at Moneyfarm, having joined in November 2022 as a Senior Investment Consultant. Prior to working at Moneyfarm, Tim has worked in financial services  since 2019, with experience across insurance, retirement and inheritance tax planning, business development and client-facing roles. He currently helps customers achieve their financial goals, conducts portfolio reviews and writes articles  for Moneyfarm. Tim currently holds an Investment Advice Diploma from the CISI – with the view of becoming Chartered in  the near future.