The actions we have taken following the invasion of Ukraine
Russia has now begun a full-scale invasion of Ukraine, initiating what could be the largest conflict in Europe since the Second World War. The West will look to respond over the coming days and weeks with heavy sanctions. These are likely to limit dollar/euro convertibility for Russian corporates, freeze the issuance of sovereign and corporate bonds, and potentially restrict US and European investors from holding Russian assets. The ultimate aim is to effectively cut Russia off from Western financing, resulting in the “Iranisation” of Russia’s public markets. The West is also considering extraterritorial export controls, similar to those used against Huawei, in order to damage key Russian industries. These controls could prevent companies in third countries from selling products to Russia. There is also a possibility of MSCI kicking Russia out of its Emerging Markets index, subject to a consultation process.
These sanctions will clearly have a significant negative impact on the Russian stock market and economy. The country will likely become even more insular, with capital markets driven by the behaviour of local rather than international investors. Importantly however, whilst the sanctions will undoubtedly hinder Russia’s longer-term economic development, in the short- to medium-term the economy is likely to be able to weather the disruption as it enjoys large surpluses, particularly after the recent windfall of higher commodity prices.
Of course, the sanctions outlined above are likely to result in retaliatory measures from Russia. The main way Putin can inflict economic pain on the West is by constricting Russia’s energy exports. Indeed, Europe relies on Russia for 27% and 41% of its crude oil and natural gas imports, respectively. Russia has already been restricting the natural gas it pipes to Europe, with volumes down by over a third compared with pre-pandemic levels. The risk now is that Putin further reduces Russia’s gas exports to Europe, and potentially restricts Russia’s crude oil exports. The goal would be to create energy shortages in Europe, while pushing up global oil prices to a point where they begin to inflict political pain in the US from voters already struggling with a cost-of-living crisis. Unless a peace deal can be struck soon, Western European economic growth is likely to slow materially as governments are forced to impose energy rationing on heavy industry.
If sanctions related to the owning or accelerated selling of Russian assets destabilise the Russian monetary system then Putin could restrict capital outflows from Russia. This adds further uncertainty for equity investors, not only in terms of whether dividends will be paid, but also as to whether they will even be able to retrieve their capital. Clearly in this environment owning Russian assets is increasingly risky. That said, having zero exposure to Russia also carries its own risks. This is an exceptionally fluid situation with many potential outcomes that could see the Russian market bouncing swiftly and sharply from extremely depressed levels. To give just one example, Putin could suddenly order a suspension in fighting to give the Ukrainian government a chance to surrender.
Taking into account all of the above, we are reducing our Russia exposure to a below-benchmark weighting in the Global Emerging Markets strategy. We currently have sell orders on all our state-owned enterprise positions, which are most at risk of direct sanctions, and are reviewing our private sector holdings on a case-by-case basis. Some of the capital has been recycled into areas of the portfolio that could be beneficiaries of the situation. For example, Middle Eastern Energy and Materials names such as OCI should benefit from higher energy prices and more generalised longer-term efforts from the West to diversify its energy exposure away from Russia.
Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).