What can investors with a fully invested portfolio do?

Many investors have a dilemma right now.

Although they agree that now is a good time to buy stocks because of the market’s very attractive valuations, they cannot buy more because they are already fully invested. Meanwhile, some investors are sitting on losing positions, which are psychologically difficult to sell because it would mean cutting losses and losing hope of a recovery.

Instead of maintaining the status quo or just selling stocks to be in cash, investors facing these issues can choose to switch some of their positions to other stocks that can go up faster when the bull market returns.

Blue chip stocks that are part of the PSEi usually lead markets higher during recoveries because these stocks are prioritized by large institutional investors. The main reason why institutional investors like them is their liquidity, making them easier to buy and sell even for those with large portfolios. Only when large cap blue chip stocks become expensive do institutional investors rotate and buy less liquid second liners or smaller capitalized stocks.

As such, investors who own second liners or smaller cap stocks can switch these first to larger cap index names that are also trading at attractive valuations.

Another reason why investors should consider switching to larger cap index names is because most of them pay cash dividends. Right now, the average dividend yield of index stocks is around 2 percent to 3 percent. These dividends provide investors with some passive income making it easier for them to wait until market sentiment improves and the bull market returns.

Investors can also choose to switch some of their stocks into bonds. There are growing signs that the United States will enter a recession soon, which should push inflation lower and convince the Fed to finally pause and even cut interest rates.

Although interest rates could still go up in the near term, Philippine bond rates are already very high compared to their historical averages. In fact, the 10-year bond rate is now at 7.6 percent, which is only 40 basis points away from its 2018 peak of 8 percent, when inflation was also elevated.

In my opinion, the risk that interest rates will permanently stay above where they are right now is very minimal. Assuming that the 170 basis points historical average spread between the 10-year bond rate and the inflation rate is maintained, inflation would have stay above 5.9 percent for the 10-year bond rates to go above its current level.

This seems unlikely given central banks’ relentless approach in preventing inflation from spiraling upwards and signs that they are succeeding. For example, in the United States, the inflation rate has already peaked and is forecast to drop to 4.2 percent next year from 8.1 percent this year. Meanwhile, in the Philippines, the inflation rate is forecast to drop to 4.1 percent next year, and 3.2 percent the year after.

Moreover, bonds perform better compared to stocks during times of economic weakness as the resulting decline in consumption leads to lower inflation and interest rates. Lower inflation and interest rates automatically lead to higher bond prices, benefiting investors who bought bonds when yields were higher. The same cannot be said of stocks as companies’ profits are also at risk of going down when the economy weakens.

The only caveat to this strategy is that investors need a significant amount of money to buy bonds directly. However, those with less money can still participate in the performance of bonds indirectly by purchasing mutual funds or unit investment trust funds that invest in bonds.