How to invest in 2023

2022 was a rollercoaster for investors – and this year is likely to be just as turbulent

The past year has been nothing short of nightmarish for investors. Dramatic falls have been recorded across the board and only three of the 13 major types of asset have generated positive returns, according to Interactive Investor, the investment service.

Conventional strategies have offered no safety. Bonds and stocks have fallen in tandem, undermining the principles of the traditional diversified portfolio of 60pc in shares and 40pc in bonds.

The volatility of 2022 has driven some investors to pile into cash, but doing so leaves them at the mercy of inflation. Here, Telegraph Money explains where to find hidden opportunities in a turbulent market and how to generate long-term returns even as a global recession looms.

Invest defensively

Higher borrowing costs and soaring inflation will leave many businesses vulnerable in 2023. 

But some companies will find it especially difficult to pass on rising costs to consumers – for example, fast fashion brands, whose average customer is very price-sensitive. Others will find that even in a deep recession their products continue to sell – think toiletries, pharmaceuticals and energy.

Jason Hollands of investment platform Bestinvest says he favours large British companies with international earnings because of their defensive tilt. 

“The FTSE 100 has an abundance of exposure to sectors that have historically proven resilient in tougher periods, such as healthcare, utilities and “consumer staples” – everyday items people continue to buy in a recession.”

Stocks that could prove resilient in a downturn include Imperial Brands and GSK.

Buy cheap

A recession can be the best time to scoop up investments while companies are undervalued.

Mark Preskitt of the investment research firm Morningstar says: “Over the long term, the price you pay for an asset is a key determinant of the returns you receive. Given time, cheap assets will outperform expensive assets.”

The difficulty is working out which companies deserve to be cheap and which are undervalued by the market.

Preskitt says: “Going into 2023 our portfolios are overweight emerging market stocks, particularly those in China and Hong Kong, as both markets appear excellent value. We also favour Brazilian and German shares.”

Rachel Winter of the advice firm Killik & Co says investors looking for cheap valuations should look to UK smaller companies, which have “sold off heavily over fears of a recession”.

Many smaller companies are trading at significant discounts relative to their larger counterparts. This makes the FTSE SmallCap index an attractive destination for investors, especially as low valuations and weaker sterling could drive acquisitions by foreign investors, which would result in a significant gain for those who bought when the stock was cheap.

Look for income

During a cost of living crisis, dividend-paying companies can provide a welcome source of passive income, particularly for those in retirement who are no longer working and are able to tolerate less volatility than younger investors.

British stocks have a strong record of paying sizable dividends to investors. One of the most important measures of a healthy dividend is a company’s “dividend cover” – earnings per share divided by the dividend per share – which gives an indication of a company’s ability to sustain its dividend. Anything below 1.5 is usually considered poor.

Bear in mind however that a company can never be completely relied on to pay its dividend, as shareholders found in 2020 when in the midst of Covid uncertainty the energy company Shell cut its dividend for the first time since the Second World War.

Give bonds a chance

Last year was one of the worst years for bonds on record. While British shares just scraped into positive territory, with a 2pc rise, global bonds lost 17pc and gilts 21pc.

But in 2023 bonds stand to benefit if interest rates start to come down, as many analysts predict.

Bonds offer much higher yields than in previous years. “If we take 10-year gilts – bonds issued by the British Government due to be repaid in 10 years – they are now yielding 3.3pc, up from a mere 0.7pc 12 months ago,” says Hollands. He says buying some bonds could make sense for next year’s portfolio, especially for the more cautious investor.

Corporate bonds could offer even higher yields. Rob Burgeman of the wealth manager RBC Brewin Dolphin recommends Robeco Global Credits. “This fund invests in investment-grade bonds across the world and in a range of sectors,” he says. 

“Its top exposure, by some way, is to the financial and industrials sectors, with some government debt as well. If we accept that inflation will peak, the dollar will weaken and interest rates may start to come down, corporate bonds are likely to offer decent returns and will be worth holding. It provides a recovery play after the bond sell-off of 2022 and should give portfolios the ballast that bonds failed to offer last year.”

Expect a bumpy road

The war in Ukraine continues to plague global supply chains while huge uncertainty surrounds inflation and global interest rates. With this in mind, investors should be prepared for market volatility.

The key piece of advice for investors going into 2023 therefore is not to panic and to stay invested. 

“Sharp drops in markets can be scary and the temptation is to ‘do something’ and sell your investments,” said Preskitt. 

“Investors need to remember that market falls do happen and try to keep a long-term perspective by staying invested to participate in the recoveries that typically follow.”

Source: The Telegraph