Ukraine Invasion: Notes from Our Investment Team

February 24, 2022
Last night’s Russian invasion of Ukraine has added to market volatility, economic uncertainty and has moved geopolitical risks to the forefront. While there are many ways this situation could play out, we wanted to send out our thoughts on current circumstances.

●    The West has announced economic sanctions against Russia, with more coming following Russia’s escalation of attacks and invasion of Ukraine. One important new sanction being considered is blocking Russia from the SWIFT global payments system, which would have particularly harsh economic effects. These types of sanctions are likely needed to get the attention of a leader like Putin.

●    One of the biggest direct economic effects is on energy markets due to Russia’s role in global oil and commodity production and as the main supplier of natural gas to Europe. This leaves European markets most exposed, and global energy markets have seen prices rise significantly, both overnight and in recent weeks.

●    Higher energy prices act like a tax on many parts of the economy and a drawn-out conflict raises the odds of a potentially stagflationary environment. These acts by Russia will likely prompt countries to re-evaluate their energy policies, both from producing traditional energy sources and investment in renewable energy to reducing reliance on countries like Russia. Energy policy is now, even more, a national security issue.

●    This may make the Federal Reserve somewhat more cautious in its policy normalization, but will not derail their plans to begin raising short-term interest rates. We feel this takes the possibility of a 50 basis point hike in March off the table; our base case is a series of 25 basis point hikes, followed by reducing the size of their balance sheet later in the year. The Fed needs to begin unwinding its highly accommodative policies to slow inflation, although, in the short term, the rise in energy prices will add to inflationary pressures.

●    While recent market volatility and declines are tied more to the Russian/Ukrainian conflict, it more broadly has been a result of hawkish pivots by global central banks this year. Just a few weeks ago we noted this about the Fed’s changing policy, “As their highly accommodative actions helped to dampen volatility, the opposite effect is expected with the removal of accommodation… We also feel the normalization of Fed policy is healthy for efficient capital allocation and the economy’s long-term functioning, which should lead to a more rational pricing of risk and interest rates in markets.”

●    Many times in history conflicts such as this have created investment opportunities due to short-term fear and emotional reactions. However, there is a risk that this could broaden out, and we are continuously evaluating the effects that multiple scenarios could have on our strategies and the companies we own. If warranted, we will make adjustments to our strategies to adapt to the evolving situation.

●    With respect to our investment strategies, we have no direct ownership of Russian companies or Russian debt, other than that held in emerging market mutual funds or ETFs. While some funds have larger Russian exposures, most have less than 2% exposure to companies domiciled in Russia.

●    Many large, global companies have exposure to Russia, including some that we own in our strategies. However, given Russia’s size of the global economy (roughly 3%), these companies’ revenue and earnings exposures are generally modest relative to their overall operations.

●    In our equity strategies, based on the valuation discipline in our investment process, we had previously increased cash holdings somewhat. With this pullback in markets, we are evaluating opportunities to take advantage of possible dislocations that we feel will be shorter-term in nature.

●    In fixed income, we are invested in high-quality companies and continue to be defensively positioned, targeting shorter durations overall. Our U.S. Treasury Inflation-Protected Securities (TIPS) allocation adds some inflation protection to clients’ portfolios and has been holding higher than typical cash balances to take advantage of market volatility.

●    Overall, we recommend that clients maintain a balanced asset allocation that fits their risk tolerance and investment horizons. Prior similar conflicts have shown that long-term equity investors should be unaffected by this market move.

The geopolitical situation and market reaction to it are in a highly fluid state at this time. We will keep you updated as we make changes to our strategies and outlook.

Thank you,

The Investment Team

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