How To Recession Proof Your Investments

Richard Hemming
Under the Radar Report is dedicated to providing ASX investors with Small Cap research so that ASX investors can build long-term wealth over all periods in the economic cycle. Do you want to learn about diversification, how many stocks to own, when to take profits and when to hold (and when to run)? Keep reading to find out. This is essential information for any ASX investor looking to build long-term wealth in the current volatile market.

The proof of Under the Radar Report's philosophy is in the pudding. Over the past 8.5 years the ASX share Portfolio has returned 63%, versus the S&P/ ASX Emerging Companies Index return of -14%.

Recession proof your investments with Small Caps

Under the Radar Report's ASX share portfolio has participated in many of the great Small Cap performers we have picked over the last 9 years. But it’s important to note that we did not fully participate. You don’t have to hit the ball out of the park all of the time; you just have to get enough right to make up for your inevitable losses.
 

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Our Small Cap investments

For instance, Clover Corp (CLV) was a Small Cap we purchased on three separate transactions at more than 50% above the lowest price we had recommended. Unfortunately, we exited at prices of more than 50% below the peak! Nevertheless, the ASX share portfolio achieved a 240% return over 2 years.

One of the stocks that does not appear in our best performing Small Caps is Macquarie Telecom (MAQ), which has still been a spectacular performer over the medium term. The ASX share portfolio had purchased this stock in two tranches in June 2014, and sold for a 70% profit some 18 to 24 month later in December 2017. Again, we bought too soon, and sold too early, but still achieved a return on investment of 45%.

We are hoping that our sale of IMF Bentham (IMF), now Omni Bridgeway (OBL) will not prove to be another one of those bad mistakes, but at the moment our sale of the balance of our position at just below $4 has seen the share price go up 25% to $5, even though we achieved a 37% annualised return on this stock.

Also, the ASX share portfolio has been lucky either to have avoided some of the worst stocks we have picked, or in a couple of cases, to have sold the balance of our holding before the company got into trouble, or into more trouble.

With hindsight, our biggest mistake is our sale of City Chic (CCX), when it was known as Specialty Fashion (SFH). We only hope that some of our subscribers may have held through the turmoil of December 2017 and held on to what has become one of our best performers.

Buy and hold investments for a recession

The reason for bringing these Small Caps up is to remind ourselves of one of the key lessons of investing success. That the real money is made by holding, not buying or selling.

The key to recession proofing your investments

It is helpful to own stocks that you believe in, make sure that you understand the fundamentals, which is where Under the Radar Report is essential. We do all the research so you don’t have to. Remain flexible enough to change your mind as the fundamental information changes, which is also where Under the Radar’s team of analysts comes in.
 

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Cash is king during a recession 

By ensuring that both your ASX share portfolio, and many of its constituent portfolio holdings, have enough cash to survive a downturn, both you and the companies you own can take advantage. Dry powder is a crucial part of your investment toolkit.

Reducing your ASX share portfolio risk

The key to understanding ASX share portfolio risk is to appreciate that while individual small stocks will be potentially very volatile, some relatively simple actions will ensure that your portfolio as a whole is much less volatile.
 
Since it is very easy to buy exposure to the broader market, through ETFs or LICs, the objective of our portfolio of smaller stocks is to find and invest in companies with uncommon (and unappreciated) growth potential, or with a significant opportunity for earnings recovery or balance sheet reconstruction, which the bigger end of the market cannot offer.
 
Under the Radar Report gives you the best Small Caps that our analysts believe offer the best resk/reward return. The primary objective when constructing a portfolio is to ensure that it does not suffer an unacceptable level of downside risk from overexposure to any particular investment theme. Yes, I’m talking about diversification.

Talking about diversification for your ASX share portfolio

There are many ways to achieve diversification, but some proved to be less effective in the COVID-19 crisis. Financial leverage, or a lack of it, is a form of diversification. Under the Radar Report ASX share portfolio more often than not favours companies with net cash balances, since they retain flexibility to determine their own destiny.
 
Essentially you should be looking to invest in companies you understand and that serve a range of different customers. These customers are the underlying strength of any business. The businesses you invest in should have different fixed and variable cost pressures and whose success rides on a variety of different themes.

Selling high risk exposure

Speculative positions in unprofitable companies can often grow to be a larger part of the ASX share portfolio than is prudent. A re-examination of the portfolio may trigger decisions to sell some of the more speculative stocks and find dividend paying or at least profitable stocks to replace them.
 
Whatever you decide to do, the best decision is sometimes to rigorously examine the portfolio with a view to its ultimate objectives, and to be willing to adjust as necessary to meet these objectives better.

Offshore exposure

Include stocks in your ASX share portfolio that have offshore revenue exposure is a sensible precaution. For instance, the Under the Radar’s Small Cap Portfolio holds the ship builder Austal (ASB) and the almond producer Select Harvests (SHV).

Options on greatness

Another form of diversification is to ensure that the portfolio has a sufficient combination of long-standing well-established operating businesses, as well as some more exciting opportunities. Thus, while the ASX share portfolio has an investment in Medical Developments (MVP), a company which is short on sales but high on promise, that is balanced by a number of operating companies.

Shareholder returns are paramount

To discourage our subscribers from risky portfolios, we emphasise Return OF Capital, rather than Return ON Capital. Your personal level of preferred risk may be higher and you can always concentrate your holdings to fewer stocks. It all depends on how much single stock risk you can stomach. One day moves of 20-25% in Small Cap stocks in both directions are common occurrences.

Preparing for a downturn

In the six months to February, most of the work preparing the portfolio for a downturn was taking profits into stock price strength before the COVID-19 virus even emerged. Our consistent message to subscribers in 2019/pre COVID 20 was to take profits and this has shown to be correct.
 
We also took swift action with two of our biggest holdings, Ingenia Communities (INA) and Village Roadshow (VRL) once it became clear the virus was likely to have a serious impact.
 
Fast forward to today and our primary concern is the pandemic and associated lockdown’s effects on economic growth. Our strategy is to avoid heavy exposure to any one particular theme.
 

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Maintaing a core of quality stocks

Part of building a balanced portfolio able to withstand most storm, is to have a true mix of exposures in the stocks we hold, exposure to value and to growth, to the cash-rich and the heavily indebted, to companies with both industrial and retail customers. For your biggest positions, you want a strong balance sheet and defensible competitive position, including Tier-1 customers. These are companies that are able to adjust if necessary to very poor conditions.
 
Austal (ASB) has been a winner over a long period of time, despite weakness in the past 12 months. Because we consider that it will continue to add to our wealth over the long-term we are prepared to buy and sell the stock as the company responds to challenges over its medium term, as its future in US becomes more uncertain. We have been trading around a core position in this stock for a while now. To find out our latest trades sign up now.

What is the right number of stocks? 

Many subscribers ask how many stocks is the “right” number for a portfolio, and like most questions in investing, the answer is different for every investor. It depends on your appetite for risk, and your level of comfort with the stocks you own. We think around 20 stocks is a reasonable number for our portfolio, since subscribers can sometimes drive prices against us, as we always publish our theoretical trades before we transact.
 
Typically, an investor new to the markets might buy small holdings in a couple of stocks at first, hopefully learn from the experience. Over time that investor should increase the number of stocks and the size of holdings as time, confidence and experience combine to create a bigger portfolio balance. Once an individual owns more than 15-20 stocks, it can become time consuming to monitor them all, and it can be a good discipline to have to decide which stock you need to sell to make room for a new idea. 

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About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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