Tips for Planning a Recession-Proof Portfolio

Consumer spending is tailing off. Real estate prices are languishing. Corporate profits are slipping. Job growth is sluggish. Purchasing managers’ activity is slowing.

It’s enough to make you fear a possible recession on the horizon. But if one comes, are you--and your investments--ready?

Making money--or at least not losing it--is not easy in a recession. Many stocks and real estate investments could be big losers. Your savings accounts won’t lose money, but their yields will look lousy as interest rates tumble.

Here are some suggestions for elements of a possible recession portfolio:

* Long-term bonds and bond funds.

These may be the best investments for a recession. Why? Because in a recession, interest rates typically fall. That increases the value of already issued bonds, giving a hefty capital gain in addition to income from interest payments. The longer the bond’s maturity, the higher the possible gain.

Such gains can be quite dramatic. Take the longest maturity bonds currently available, 40-year bonds issued by Refco (short for Resolution Funding Corp.), a federal agency created to help finance the savings and loan bailout.

The “stripped� zero-coupon versions of these bonds--those that don’t make periodic interest payments but instead are sold at a deep discount from their face value--will produce a whopping annualized gain of 166% if interest rates fall 1.5 percentage points in six months, according to Larry Biehl, director of Bailard, Biehl & Kaiser, a San Mateo, Calif., investment advisory firm. If rates fall only 1 percentage point in six months, the gain on an annualized basis is 103%.

Gains on 30-year zero-coupon Treasury bonds can also be quite impressive, Biehl notes. If rates fall 1.5 points in six months, your gain is 117%; if that happens in 12 months, the gain in 41%.

But timing is important. If rates go up instead, as can happen in a recession, you will lose money--but your loss won’t be quite as big as the potential gain.

How can you invest? You can buy bonds from a broker or through bond mutual funds. The most extensive family of bond funds investing in zero-coupon Treasuries is Benham Management Corp., at (800) 472-3389. Its Target funds allow you to pick the maturity you want, depending on the risk you wish to take.

* Cash equivalents.

In a recession, you’ll want to have access to lots of cash. For one, things could really get bad and you might lose your job. Also, you’ll want cash to take advantage of the many bargains that will become available, particularly in stocks and real estate.

What’s the best vehicle to hold cash in a recession? Federally insured savings deposits are among the safest, but you might consider money market mutual funds. They are virtually as safe as federally insured savings, but yields are better than many bank and thrift accounts. And you can get your money out more quickly than certificates of deposit and Treasury securities.

* Gold and gold funds.

Gold normally rises during times of inflation, not when prices are falling, as is sometimes the case in a recession. But gold also does well during severe economic crises and political turmoil, argues John Markese, research director for the American Assn. of Individual Investors.

“If there’s a calamity involved, gold makes sense,� Markese says. You can buy the metal directly, but a better bet might be to buy stocks of gold-mining firms, either directly or through mutual funds. Unlike the metal, gold stocks pay dividends. They also are more volatile, moving up or down quicker and farther.

* Stocks and stock funds.

Stocks of utilities, food processors and non-durable goods manufacturers tend to do better in economic bad times, says Donald J. Phillips, editor of Mutual Fund Values, a Chicago-based investment advisory service. On the other hand, he says, recessions are hard on stocks of firms in cyclical industries such as autos, transportation and natural resources.

It’s also a good idea to maintain some investment in European and Asian stocks or international-stock mutual funds. “Not every country goes through a recession at the same time,� Phillips says.

But timing is also important. Stock prices normally decline prior to the start of a recession and for the first few months into it. You may not want to buy until the recession is well recognized and discounted.

Phillips outlines three categories of stock mutual funds suitable for a recession portfolio. The most conservative category, income funds, generally invest in bonds and stocks paying high dividends and generally offer yields of about 7% to 8%. In this group, he likes Value Line Income (800) 223-0818, USAA Income (800) 531-8000 and Wellesley Income (800) 662-7447. All invest heavily in utility stocks and high-quality bonds.

He also likes balanced funds, which are a bit more aggressive in the stocks they pick. In this group, Phillips likes Twentieth Century Balanced, (800) 345-2021, which is heavily invested in consumer non-durables, retailers and utilities; Pax World, (603) 431-8022, a stock and bond fund that applies social and ethical criteria to its investment choices, and Axe-Houghton Fund B, (800) 366-0444, now heavy into utilities and financial services.

More aggressive investors might be interested in a third group of equity funds that includes Lindner Dividend, (314) 727-5305, now heavily into utilities and financial services firms, Phillips says. It did well in the last recession, rising 26.3% in 1981 when the Standard & Poor’s 500 fell 5%.

He also likes SoGen International, (800) 334-2143, a fund that has never had a down year since 1978, when its current manager took over; Greenspring, (301) 435-9000, which invests part of its portfolio in troubled firms expected to come back, and Pennsylvania Mutual, (800) 221-4268, which specializes in small companies and has not had a down year since 1973, when one of its co-managers took over.