View all posts

What the Russia-Ukraine conflict may mean for markets and our portfolio positioning


Global markets have had a rocky start to the year. Just as markets came to grips with rising inflation and monetary tightening globally, fears over a Russian invasion of Ukraine intensified. Firstly, major global wars are generally not good for sentiment, certainty, economic growth, and market returns. Secondly, sanctions on Russia have the further potential to disrupt global oil supply which will likely amplify the negative fall-out.

Russia and the Ukraine’s shared heritage goes back more than a thousand years and the battle for Ukraine has persisted for almost as long. Most of Ukraine’s “greatest traumas”, as the National Geographic terms, was suffered in the 20th century. After a brutal civil war, Ukraine was absorbed into the Soviet Union in 1922. In the 1930’s, following a famine orchestrated by Stalin to force peasants to join collective farms, many Russians were brought in to help repopulate the east. This means that the east of the country still has strong ties to Russia to this day, while the west (which spent centuries under the control of various European powers) does not. 

This split has been sporadically laid bare in the last 20 years. In the 2004 Orange Revolution, thousands of Ukrainians from the west and central parts of the county marched to support greater integration with Europe. The Euromaidan began when then Ukrainian president Viktor Yanukovych refused to sign an association agreement with the European Union in 2013. Yanukovych, who drew most of his support from eastern regions, was forced out of office in February 2014. Crimea was occupied and annexed by Russia in the same year, followed shortly after by a separatist uprising in the eastern Ukrainian region of Donbas, that resulted in the declaration of the Russian-backed People’s Republics of Luhansk and Donetsk. 

Russian troops have been active in the region since and diplomatic relations have deteriorated. Throughout 2021 and 2022, Russian military build-up on the border has escalated tensions between the two countries. Over the last few weeks, messaging on a possible Russian invasion or incursion has been mixed, with Russia mostly denying plans to attack while the US has maintained that the threat level was high. Several world leaders have tried to intervene including US President Joe Biden, French leader Emmanuel Macron and newly elected German chancellor Olaf Scholz.

Despite this, on 24 February 2022, Russia invaded Ukraine.

What now?
The situation is incredibly fluid currently.

Back in January 2020, when we were exploring the possibility of a global war centred around Iran, Andreas Kluth wrote an article for Bloomberg where he explored the possibility by applying Game Theory to answer the question of whether a full-scale war would break out. Game Theory is a branch of mathematics that has been used since the 1960s in nuclear scenarios. 

“The initial games included simple classics such as ‘chicken’ and ‘the prisoner’s dilemma.’ One disturbing insight is that, depending on the game, even rational players acting rationally can end up in situations (called Nash equilibria) that are disastrous for everybody.”

He suggested that these situations can be improved by adding a mediator. The focus by the West thus far has been on diplomacy and “mediators” have not been in short supply. The problem is just that those willing to mediate are the West and not allies of Russia.
Another option is disincentivising Russia from continuing the aggression. Harsh economic sanctions – and particularly energy sanctions – may also weaken the Russians resolve to continue. But this will have knock on impacts as well.

The market reaction
Global equity markets sold off aggressively after news of the invasion broke. 

The gold price approached $2 000/oz. as its safe-haven status has again seen investors flock to the yellow metal as a store of value.

The Brent crude oil price spiked to above $105 per barrel amid fears that oil supply from Russia will be limited, as harsher economic sanctions may be required. 

Platinum Group Metal (PGM) prices have rallied since most of the world’s supply of PGMs are in Southern Africa and Russia. As is the case for oil, supply from Russia will be heavily impacted by sanctions.

Portfolio management at Ashburton Investments
We understand that such times can be troubling for investors. 

Our portfolio management approach hinges on forming a view of the most likely outcome given the prevailing circumstances, what we term our “base case” scenario. This is predicated on strong, coordinated global fiscal and monetary policy response to alleviate the stress created from impending economic contraction.

It is also prudent to consider that in circumstances as uncertain, unprecedented and as fluid as those we currently face, the risks to our base case scenario are material. 

As such, we construct a stress scenario whereby the required fiscal stimulus is insufficient and/or the combined impact of the crisis is much worse than anticipated, resulting in the financial system becoming increasingly stressed. 
In this scenario, the result would first be economic contraction, which then leads to a financial market crisis. While the likelihood of this occurring is currently quite low, considering its possibility allows us to adequately prepare our portfolio responses for such a scenario.

Portfolio positioning at Ashburton Investments
Our positioning is being rigorously debated and reviewed on a daily basis given the current high levels of market volatility. We are reassessing our base case, not losing sight of the stress case and are well prepared to adjust our portfolios accordingly.

The following summarises our current house view portfolio positioning:

• Our portfolios remain well diversified from an asset, geographic and sector perspective. Our direct equity exposure consists of quality blue chip equities that have minimal economic exposure to Russia. We have no direct holdings across our portfolios.
• Our bond exposure is diversified across US Treasuries, investment grade, and short duration credit (less sensitive to cyclical factors) with no Russian bond holdings.
• Our alternatives exposure includes commodities, real estate and low beta infrastructure investments, all outside of Russia.
• Within our direct equity exposure, we are underweight in highly economically sensitive or cyclical businesses (e.g. basic materials and industrials, and consumer stocks) and overweight staples (e.g. health and household), pharmaceutical and technology – namely those companies that have recurring revenues.

The investment team focusses on the underlying impacts that such disruption will have on the investments made. It is worth remembering that the prices of equities are determined by the marginal buyers and sellers. The underlying value of the companies themselves depends on the future cash generated by these businesses. 

Concluding remarks
Firstly, the situation in Ukraine is bleak and many of its citizens are facing a humanitarian crisis and our thoughts go out to those affected by this tragedy. 

Investors have been trying to make sense from this fallout which clearly, in the short-term, remains highly volatile and uncertain. It has been made complicated by a higher inflationary backdrop made worse by higher energy prices as a result of the crisis. Given a mandate of stable prices and employment the war is unlikely to stop the US and UK central banks from raising interest rate this year, although the ECB is now less likely to do so until later this year.

We will remain cognisant of the risks and are unsure of how long the aggression will last, we will also be looking for opportunities in weakness.