What Does the Russia/Ukraine Crisis Mean for Investors?

I’d like to begin away from the technicalities of investments and pensions.  Instead, I’d like to start by extending my thoughts, hopes and sympathies at this time to the people of Ukraine and innocent parties impacted by the devastating events we are seeing unfold. 

What does the current crisis mean for Trustees?

Global equity benchmarks have a small allocation to Russia, only c.0.4%. In the MSCI Emerging Market Index, Russia only accounts for 2.8%. Numbers that are quickly shrinking as investors, globally, have looked to make disinvestments. The MSCI Ukraine Index only has two constituents both in the agricultural sector and most investors would have limited exposure to them. Therefore, the large global equity market declines, and accompanying volatility, are due to the wider implications of the invasion:

• The fear of the unknown. Nobody knows what will happen, which is causing panic selling. There is a broad range of outcomes including: how long will military assault on Ukraine last, will there be more cyber-attacks on business from Russia, will China get involved, will nuclear weapons get used?
• Rising Energy Prices. Russia is the second-largest oil exporter after Saudi Arabia and the world’s top producer of natural gas. Russia accounts for 40% of European natural gas supplies. Therefore, economic sanctions against Russia would reduce future energy supplies, driving up prices further. It is no surprise the price of energy is increasing with brent oil up from c.$97 to c.$118 since the start of the invasion. Commentators are making forecasts oil could hit $150. Going forward, perhaps Europe may want to reduce its dependency on Russian oil, which may accelerate the energy transition to renewables.
• Reduced economic growth. Rising energy prices have negative effects on most parts of the economy reducing economic growth and corporate earnings, resulting in share price declines.
• Higher inflation. With UK inflation at 30-year highs, the rising energy prices will likely lead to more inflation as the cost-of-living increases.
• Interest rates hikes. Central banks have already started raising interest rates to combat inflation. If inflation continues to increase, more rates hikes could be on the way. Rising interest rates cause equity and credit valuations to decline.

The result on pension schemes is:

• We anticipate continued volatility in asset valuations as uncertainty continues
• Rising inflation, from already high levels, may have only a limited impact on liabilities due to caps on pension increases and deferred revaluation.
• Gilt yields are likely to increase, to help reduce sustained high inflation. If yields increase, this will act to reduce liabilities depending on the extent a hedging strategy is in place.

Looking beyond investments, some schemes may face a sharp downgrade in their covenant due to exposure to Ukraine or Russia.   

Final Thoughts

Historically most geopolitical shocks do not result in long bear markets and while current losses are large, markets generally recover relatively quickly as the crisis recedes.  

In these times of crisis, as trustees we need to remember the principle of diversification more than ever to reduce volatility. While equities are down, other safe haven assets are up, including gold and government bonds.

Top-down macro analysis is hard and predicting what will happen in the world is a challenge. Who knew Covid would happen, or Russia would invade Ukraine? It is important for Trustees to maintain a disciplined investment process that focuses on the long-term approach and avoids making decisions on short-term headlines.