Best ETFs to buy in a recession

With tough financial times approaching and a recession on its way, what are the most interesting exchange-traded funds right now? We look at some of the options available to investors.

Pros and cons of ETFs

Buying exchange-traded funds (ETFs) can be a good way to spread risk. ETFs work by automatically tracking an index, such as the FTSE 100 or S&P 500, or a particular industry sector, such as real estate.

You can buy ETFs in a number of different types of investments, including equities, bonds and commodities. Like actively managed funds, they invest in a large basket of investments, spreading the risk, but without the cost of human fund managers.

As they passively track an index or sector, they tend to have cheaper fees. For example, the expense ratio for the Vanguard Dividend Appreciation ETF fund is 0.06%. Typical fees for an actively managed fund can be 0.7% to 1.7% or more. These expensive fees can eat into investment returns, meaning your money must work even harder.

IG has a useful guide here explaining the pros and cons of investing in ETFs, how they work and how to go about doing so.

A wide variety of ETFs

It’s possible to buy ETFs in numerous industry sectors and areas, including gold, oil and gas, technology companies and even real estate. However, ETFs in bitcoin have been slow to get off the ground due to regulatory concerns.

The downside of passive funds is that they can be slower in responding to investment trends, such as a stock market downturn, because of how they are run. Plus, like any fund, they are also only as successful as their holdings.

Here are three ETFs that could be a good option to invest in for the coming recession. These have been selected for certain investment criteria, such as their market capitalisation, dividends, past performance and investment profile.

The iShares Global Healthcare ETF

Healthcare is a classic defensive safe haven for investors in difficult economic times. Demand for healthcare services and pharmaceuticals continue, despite financial pressures and large drug firms often command strong pricing power for their products even when times are tough.

The iShares Global Healthcare ETF is run by Blackrock and tracks the S&P 500 healthcare sector. It invests in pharmaceutical, biotech and medical device companies and has 114 holdings. The fund has delivered cumulative total returns of 60.27% over five years and 36.9% over three years, although it is currently down 1.1% over one year. At present, its top ten holdings include AstraZeneca, Johnson & Johnson, United Health, Eli Lilly, Novartis and Pfizer.

Currently it is 64% invested in pharma, biotech and life sciences, and 35.6% in healthcare equipment. The bulk of the ETF’s holdings are in US companies, with 72% of its holdings there, 8% in Switzerland, 4% in Japan and 4.6% in the UK. Its expense ratio is slightly more expensive than many ETFs, coming in at 0.4%.

While the recent performance has been disappointing, it could perform well going forward as investors continue their flight into defensive stocks from growth shares.

SPDR MSCI Europe Utilities UCITS ETF

Utilities are another common defensive sector to invest in during tough economic times. This is because their revenues tend to be relatively stable, compared to those of cyclical industries, and the dividends reliable and attractive. It may also be a good way to benefit from high electricity prices in the UK and Europe, although there is the current risk that governments may introduce windfall taxes.

As its name suggests, the SPDR MSCI Europe Utilities UCITS ETF tracks large and medium-sized companies in the European utilities sector - the MSCI European Utilities 35/20 Capped Index. Run by State Street Global Advisors, the fund has delivered a return of 9% over five years, 8% over three years and 2.9% over one year.

Its top ten stock holdings include Iberdrola, National Grid, Enel, RWE and SSE. Currently the fund is 54% invested in the electricity sector and 27.5% in multi-utilities. At present, 23% of its holdings are in the UK, with 23% in Spain and 15% in Italy. The ETF has a total expense ratio of 0.16% and 25 holdings.

Vanguard Dividend Appreciation ETF

When the chips are down, solid dividend income is something worth focusing on. The Vanguard Dividend Appreciation ETF invests in America’s top dividend paying companies, tracking the S&P US Dividend Growers Index. Some of its top 10 holdings include United Health, Johnson and Johnson, JP Morgan Chase, Procter & Gamble and Microsoft.

It has delivered returns of 11.9% over 10 years and 9.5% over three years, although the performance over one year is disappointing, down 5%. It is also low cost, with an expense ratio of just 0.06%.

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* Based on revenue excluding FX (published financial statements, June 2021).