Five ways to protect your portfolio in a bear market

Published by Cherry Reynard on 28 September 2010.
Last updated on 29 September 2010

downward line

Go for well-financed companies

Derek Stuart, manager of Artemis UK Special Situations fund, says: "Companies need to have appropriate debt rather than no debt. Some companies with steady cash flows can afford to take on some debt.

"Others cannot. Balance sheet strength will be a much bigger issue over the next few years. It will give companies the flexibility to undertake investment or acquisitions."

Look for structural growth

If, as is expected, the UK economy shows anaemic growth for the next few years, cyclical companies (those that move up with the economic cycle) are likely to struggle.

Investors should therefore look for companies with a unique growth story, such as an exposure to emerging markets or a market-leading product.

Stick to compelling valuations

A lot of cyclical stocks moved up a long way in the unfortunately named 'dash for trash' rally of 2009. Markets are now working on the basis of growth rates based on last year's strong rebound. But expensive stocks are likely to be the first to be marked down if growth rates fall.

Go global

The UK market offers plenty of companies with global franchises. UK stockmarket giants such as GSK, Smiths Industries and Reed Elsevier have long realised that it makes better business sense to focus on six billion global consumers than to limit their options to 55 million domestic consumers. Global companies can also access faster-growth countries.

What investments should i avoid?

Usually, the investments to avoid in a downturn would be higher-risk areas such as smaller companies, emerging markets and technology. But none of these areas look significantly over-valued, and most successfully weathered the recent downturn.

Technology, in particular, looks reasonable value, and Gavin Haynes, managing director at Whitechurch Securities, for example, has recently started re-examining the sector for inclusion across his portfolios.

The emerging market story remains strong, with much of the next phase of global growth coming from giants such as China, India and Brazil.

The areas to avoid are those that have seen a significant run-up over the past year, including many of the cyclical areas such as mining, where the market is now pricing in continuing punchy growth rates.

Commodities are dependent on global demand and any return to recession, particularly in the US, would dent prices.

The most important rule is to avoid areas that look expensive on an historic basis, as higher valuations are a luxury purely for bull markets.

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