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March 04, 2022

Russia – Ukraine: Risk and Investment Implications

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March 04, 2022

Russia – Ukraine: Risk and Investment Implications


PATH

Russia – Ukraine: Risk and Investment Implications

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March 04, 2022

 
 

February was marked by the escalating tensions and a full-scale Russian invasion of Ukraine. Many asset classes were already on a downward trend since the beginning of 2022, given inflation pressures, concerns over rate hikes and deterioration in investor sentiment. However, as the situation between Russia and Ukraine rapidly worsened over February, asset classes that had already sold off, such as the major developed equity regions, sold off further, with the S&P 500 moving deeper into correction territory, while the Nasdaq moved closer to a bear market.

 
 

The S&P 500 (USD), MSCI Europe Index (EUR) and MSCI Emerging Market Index (USD) declined around 3.0% over the month, with the MSCI Japan (JPY) faring slightly better, down 1.1%1. Unsurprisingly, Russia was hardest hit, with the MOEX Russia Index (RUB) plummeting 30.0%1. At the same time, the price of crude oil rose to levels not seen since 2014, due to heightened concerns over disruptions to global energy supplies. The VIX2 ended the month at 303, as the conflict intensified, and international sanctions tightened around Russia.

Implications on inflation and monetary policy

In our team’s recent market outlooks, we have highlighted our view that inflation is not transitory, but is likely to persist, at least through the first half of 2022. A prolonged conflict would keep upward pressure on energy prices, and in turn contribute to upward pressure on inflation. However, there is likely to be a notable difference between Europe and the US in this respect, given that Europe is highly reliant on imports of Russian gas, but currently has low inventories. Our view of the impact of this crisis on inflation – and any implications for our portfolio positioning - is therefore one area of active discussion within the GBaR team. The impact of the crisis on global growth and on monetary policy are other areas of focus.

Investment Implications

We entered 2022 already cautiously positioned. At the time, we were talking of Russia/Ukraine tensions as a potential near-term risk and we were therefore monitoring the situation closely, but they were by no means the only risk. For example, during January, increasing evidence of US Fed hawkishness, inflation becoming embedded, concerns over decelerating growth, and deteriorating investor sentiment, were equally important in driving our forward-looking volatility expectations. This was in an environment in which certain areas of the equity market, such as US equity stocks and large tech names, still appeared overvalued.

Our view is that the military conflict in the Ukraine is unlikely to end quickly; the situation is likely to worsen, before it improves. We therefore expect volatility to persist in the short term, so remain cautious in our positioning, in fact we felt it prudent to further reduce exposure to risk assets. Considering the above, we reduced equities further in February, from a level that already reflected caution. We believe that in the near term, this should position us well to weather the near-term market volatility. In addition, we remain underweight duration, given rising yields. We also made the following tactical changes:

Broad Global Commodities

At the beginning of February, we added an overweight exposure to broad global commodities, as an explicit hedge against an escalation in Russia-Ukraine tensions. Given ongoing signs of supply constraints within the commodity complex, we believe the downside risks to this trade are limited. We increased this position towards the end of February given our concerns at the speed with which the situation was deteriorating, and the increased likelihood of a full-scale invasion, such as we now have seen.

European Banks

At the beginning of the month, we reduced exposure to US Financials, in favour of their European counterparts. At the time our view was that European banks may benefit more from rising net interest income on higher rates, and may deliver higher capital returns, than their US counterparts. Since then, the Russian invasion of Ukraine has changed the dynamics, requiring a review of the position towards the end of the month.

UK Equities

We moved overweight UK equities, expressed through the FTSE 100, providing a blend of value and defensiveness through exposure to energy, materials, and consumer staples companies. We believe that an attractive valuation discount and lower (real) rate sensitivity, adds to the defensive character of the FTSE 100 in the current environment.

Active US Growth

For portfolios which allow active funds, we trimmed the US growth active managers, in favour of broader S&P 500 exposure, to achieve a small underweight in large and mega-cap growth stocks. With slowing growth, near-term inflation pressures, and rising nominal and real rates, we expect to see continued pressure on US mega-cap names, which still trade at substantial 12-month forward PE premiums to the broader market.

Tactical positioning

We have provided our tactical views below:

 
 
 

Source: MSIM GBaR team, as of 28 February 2022. For informational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The tactical views expressed above are a broad reflection of our team’s views and implementations, expressed for client communication purposes. The information herein does not contend to address the financial objectives, situation, or specific needs of any individual investor.

 
 

The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results.  See Disclosure section for index definitions.

1 Bloomberg, 1-month performance, as of 28 February 2022.

2 VIX is used as a measurement of volatility.  

3 Bloomberg, as of 28 February 2022.


 
 

RISK CONSIDERATIONS

There is no assurance that the Strategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them.  Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.  Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets.  Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. A currency forward is a hedging tool that does not involve any upfront payment. The use of leverage may increase volatility in the Portfolio.

 
andrew.harmstone
Managing Director
Global Balanced Risk Control Team
 
manfred.hui
Managing Director
Global Balanced Risk Control Team
 

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INDEX DEFINITIONS

The indexes shown in this report are not meant to depict the performance of any specific investment, and the indexes shown do not include any expenses, fees or sales charges, which would lower performance. The indexes shown are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Forward P/E: Price-Earnings (P/E) is the price of a stock divided by its earnings per share for the past 12 months. Sometimes called the multiple, P/E gives investors an idea of how much they are paying for a company’s earning power. The higher the P/E, the more investors are paying, and therefore the more earnings growth they are expecting. Forward to price earnings (P/E) is a measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation.

MOEX Russia Index is the main ruble-denominated benchmark of the Russian stock market. It tracks the 50 largest companies on the Moscow Stock Exchange. It has the same composition as the dollar denominated RTS Index.

MSCI Europe Index: The MSCI Europe Index captures large and mid-cap representation across 15 Developed Markets (DM) countries in Europe.

MSCI Emerging Markets Index: The MSCI Emerging Markets Index (MSCI EM) is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance of emerging markets.

MSCI Japan Index: The MSCI Japan Index is designed to measure the performance of the large and mid-cap segments of the Japanese market.

NASDAQ Composite Index: A broad-based capitalisation-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market.

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

VIX©: This is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 Index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period.

DISCLOSURES

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular Strategy may include securities that may not necessarily track the performance of a particular index. A minimum asset level is required.

For important information about the investment managers, please refer to Form ADV Part 2.

The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.

This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Past performance is no guarantee of future results. Charts and graphs provided herein are for illustrative purposes only.

The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

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A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment managers, please refer to Form ADV Part 2.

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