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Where to Look for Recession-Proof ETFs in 2020

By Catherine Brock - Updated Aug 4, 2020 at 5:08PM

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Sector ETFs might be just what you need to sleep better at night.

The stock market may be in an optimistic frame of mind, but the U.S. economy is not in a good place right now. The latest report from the U.S. Bureau of Economic Analysis (BEA) estimates that the U.S. real gross domestic product (GDP) decreased at an annual rate of 32.9% in the second quarter of 2020. That's the fastest, steepest economic contraction in modern history.

Optimists will argue that the cause of the second-quarter drop-off, shelter-in-place orders, is now a thing of the past. But there's another economic datapoint that implies we're not out of the recession woods just yet. In the last two weeks of July, unemployment claims started rising again, after declining for nearly four months.

Man with hands on his head, facing a screen with economic indicators pointing down.

Image source: Getty Images.

You can interpret that news as a signal to recession-proof your portfolio, and exchange-traded funds (ETFs) can help you do it.

What to like about ETFs

ETFs are generally appealing for a few reasons. Like all mutual funds, they're diversified. But they often have lower fees and are more tax-efficient than mutual funds. Mutual funds that do a lot of trading will generate capital gains and push those to shareholders as taxable distributions. ETFs tend to have lower turnover and lesser capital gains as a result.

To find recession-proof ETFs that'll add some stability to your holdings, look to products and services that consumers will still buy even after a loss of income -- such as consumer staples, utilities, and telecommunications.

Consumer staples

Over the last 10 years, the S&P Consumer Staples Sector Index has returned annualized growth of 12%. That's a notch below the S&P 500 index's 10-year annualized return of 13.75%, but it's been a smoother ride for the staples sector. When the S&P 500 index fell 34% from its February highs in March, for example, the consumer staples index only dropped 24%.

A popular ETF in this space is Consumer Staples Select Sector SPDR ETF (XLP -0.13%). It has a low expense ratio of 0.13% and holds positions you'll recognize, like Procter & Gamble (PG 0.07%), Walmart (WMT 0.73%), and Coca-Cola (KO -0.90%).

Another low-cost option is the Vanguard Consumer Staples ETF (VDC 0.13%). This ETF is more diversified than the SPDR version, with 94 positions versus XLP's 33. The Vanguard ETF tracks the performance of the MSCI US IMI Consumer Staples 25/50 Index and has an expense ratio of 0.10%.

Utilities

Utilities, like consumer staples, aren't going to outperform in bull markets, but they offer some nice downside protection during recessions. Note that general utilities ETFs will have exposure to nonrenewable energy sources, which might not be where you want to invest your cash.

For utilities ETFs, look to low-cost fund powerhouses Vanguard and Fidelity -- each has an ETF that tracks the MSCI US IMI Utilities 25/50 index. Vanguard Utilities ETF (VPU 0.12%) has an expense ratio of 0.10% and $5.06 billion in net assets. Fidelity  MSCI Utilities Index ETF (FUTY 0.80%) has an expense ratio of 0.08% and $821 million in net assets. Both funds are most heavily weighted in electrical utilities and have less than 3% of their holdings in renewable energy sources.

Telecom and communications

Telecom companies like Verizon Communications (VZ -0.82%) and AT&T (T -1.39%) keep people connected, and that's important during recessions -- especially when said recession is prompted by a global pandemic.

iShares U.S. Telecommunications ETF (IYZ 1.19%) gives you exposure to U.S. companies providing telephone and internet services and related technologies, including Verizon, AT&T, T-Mobile (TMUS -0.17%), and Garmin (GRMN 1.19%). The fund has an expense ratio of 0.42% and $355 million in assets under management.

Communications services funds are a slightly different animal, but also appealing. These hold the old-school telecom providers like AT&T, along with technology players like Alphabet (GOOGL 0.06%) and Facebook (META 2.90%). This could be a riskier approach since these younger tech companies don't have the history of recession resilience that pure telecom does.

Two low-cost communications ETFs are Vanguard Communication Services ETF (VOX 0.97%) and Fidelity MSCI Communication Services Index ETF (FCOM -0.69%). Both are passively managed to track the MSCI US IMI Communication Services 25/50 Index. The Vanguard fund has an expense ratio of 0.10%, while Fidelity holds its fund's expenses at 0.08%.

ETFs for downside protection

Sector ETFs in consumer staples, utilities, and telecommunications may be the least interesting positions in your portfolio. But if the U.S. economy falls deeper into recession and the stock market responds badly, your dullest holdings may be the ones you appreciate most.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Catherine Brock owns shares of AT&T, Coca-Cola, and Procter & Gamble. The Motley Fool owns shares of and recommends Alphabet (A shares) and Facebook. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.

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Stocks Mentioned

The Select Sector SPDR Trust - The Consumer Staples Select Sector SPDR Fund Stock Quote
The Select Sector SPDR Trust - The Consumer Staples Select Sector SPDR Fund
XLP
$74.54 (-0.13%) $0.10
Vanguard World Fund - Vanguard Utilities ETF Stock Quote
Vanguard World Fund - Vanguard Utilities ETF
VPU
$161.45 (0.12%) $0.19
Vanguard World Fund - Vanguard Consumer Staples ETF Stock Quote
Vanguard World Fund - Vanguard Consumer Staples ETF
VDC
$192.45 (0.13%) $0.24
iShares Trust - iShares U.S. Telecommunications ETF Stock Quote
iShares Trust - iShares U.S. Telecommunications ETF
IYZ
$26.42 (1.19%) $0.31
Vanguard World Fund - Vanguard Communication Services ETF Stock Quote
Vanguard World Fund - Vanguard Communication Services ETF
VOX
$100.36 (0.97%) $0.96
Fidelity Covington Trust - Fidelity MSCI Communication Services Index ETF Stock Quote
Fidelity Covington Trust - Fidelity MSCI Communication Services Index ETF
FCOM
$37.70 (-0.69%) $0.26
Fidelity Covington Trust - Fidelity MSCI Utilities Index ETF Stock Quote
Fidelity Covington Trust - Fidelity MSCI Utilities Index ETF
FUTY
$48.16 (0.80%) $0.38
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
VZ
$44.58 (-0.82%) $0.37
AT&T Inc. Stock Quote
AT&T Inc.
T
$18.09 (-1.39%) $0.26
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$117.54 (0.06%) $0.07
The Coca-Cola Company Stock Quote
The Coca-Cola Company
KO
$62.81 (-0.90%) $0.57
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
WMT
$127.50 (0.73%) $0.92
The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
PG
$144.82 (0.07%) $0.10
T-Mobile US, Inc. Stock Quote
T-Mobile US, Inc.
TMUS
$144.31 (-0.17%) $0.25
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
META
$171.96 (2.90%) $4.85
Garmin Ltd. Stock Quote
Garmin Ltd.
GRMN
$98.77 (1.19%) $1.17

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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