When we hit a crisis such as war in Ukraine, the first order and ‘direct’ impacts on markets are typically very quickly discounted. We saw this in the dramatic fall in share prices of Russian equities and Russian exposed stocks listed on the London Stock Exchange.
As a business we’ve fielded numerous questions from clients and stakeholders about our direct exposure to Russian stocks. While a timely and relevant question, given the very limited exposure of most asset managers such as ourselves to direct Russian assets, the big issues and consequences for equity investors from the invasion of Ukraine are indirect, complex and will take time to fully emerge. In our view it’s possible to break down the impacts of the invasion into three parts of increasing investment significance: indirect stock impacts, indirect macro impacts and the not so small matter of long-term ‘system change’ for the global and corporate economy.
Indirect stock level impacts
- Business operations in Russia: Most multi-national companies have between 1-5% of their sales and operations in Russia given a population of 145 million in a G20 economy. It is likely these assets are permanently impaired in value either as companies choose to exit Russia or the Russian economy weakens significantly.
- Commodity inflation: The world relies on wheat, oil, gas, coal and metals exports from Russia. Russia is about 10% of global oil & gas production for example. Severe disruption to commodity supplies is causing the earnings of other suppliers globally to rise dramatically while creating severe input cost increases for companies reliant on commodities as an input cost.
- Counterparty risk: This is particularly the case for European banks with significant loan exposures into Russia. With sanctions and the curtailment of payment systems/networks to Russia it is quite possible these loans and counterparty obligations will have to be written off, or at least are simply not callable for an extended period of time. The significance of this varies between companies but is causing concern.
- Supply chains: Parts of the European supply chain infrastructure are reliant on Russia and Ukraine and these are being disrupted. Whether it is software engineers in Kyiv or auto parts from Ukraine, there are parts of the European supply chain impacted.
Macro level impacts
All of the above are generally inflationary for the economic system. Whether it is our gas prices, wheat prices, increased conservativism at financial institutions or supply chain disruption, inflationary pressures are increasing. This could well cause a recession and either way higher inflation will likely impact the course of monetary and fiscal policy in western liberal democracies in the near term. As the risks of stagflation increase (more inflation, lower growth with crowded out consumer spending and corporate investment) we are seeing a flight to quality growth and risk-off stocks with a commensurate move away from non-commodity cyclicals and riskier stocks, whether they be concept growth stocks or things like banks with their financial leverage.
So, while the direct impacts of the war in Ukraine are limited in most investors’ portfolios, Russian assets were already quite well disconnected from the global listed financial economy, the indirect impacts on inflation, interest rates, risk-appetite and individual companies are much more significant. Our focus as active managers is to assess these complex topics before incorporating the impacts into our analysis and portfolio construction.
As always, given the unpredictable nature of what can happen next in the world and financial markets it speaks to the value of focusing primarily on higher quality businesses over a business and investment cycle, and also diversifying portfolios to protect the robustness of long-term outcomes for clients. An example right now might be having an exposure to commodity companies that offsets some of the impacts of an exposure to the users of commodities.
The invasion of Ukraine by Russia is first and foremost a humanitarian disaster and tragedy. I hope for a speedy and peaceful resolution for the sake of all those involved. Seeing the donations from companies such as Royal London or the collections in my local community, it reaffirms my belief in liberal democracies where governments have the confidence not to throttle the press and the free flow of information. From an investment perspective there are significant indirect stock specific and macro impacts that continue to significantly influence markets and savers.
Our focus is on navigating these through our portfolios and the range of future outcomes remains wide given so much uncertainty as to how the war develops. It will also take time for the indirect impacts to properly manifest themselves in the global economy, inflation, supply chains and corporate profitability. In the longer term I am of the view that what is happening in Ukraine will go down in the history books as a key catalyst in the re-ordering of the shape and structure of the global economy and corporate economy.
Past performance is not a reliable indicator of future results. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.