After weeks of building tension and diplomatic pressure, Vladimir Putin has initiated a full-scale invasion of Ukraine. At the moment, the West’s reaction appears limited to economic sanctions rather than a military response and so long as Russia’s attacks do not extend into Nato countries we can hope that descent into a wider conflict can be avoided.
The response of equity markets to the news has been negative with the Euro Stoxx 50 off nearly 5%1 and the FTSE 100 down more than 3%[1] on the day of invasion. Selling has been broad based with sectors such as banks, airlines and autos worse affected and although energy has held up better, the impact is mixed with companies such as BP owning sizeable production assets within Russia. While the news flow is clearly disturbing, we would note that in previous conflicts, such as the Russian invasion of Afghanistan, the Iraq Wars of the 1990s and 2000s or the breakup of Yugoslavia, markets have tended to rally once conflict has actually broken out. Moreover, Russia accounts for just 1.6% of European company sales and 3% of its exports so its direct economic importance is limited1.
Beyond the impact on market sentiment, the immediate implications of the invasion are for commodity prices. Oil prices have breached $100 on expectations of supply disruptions due to sanctions on Russia which accounts for 10m bpd of global oil production and about a quarter of European supply1. Natural gas prices in Europe are up 41%, although the region is beyond peak vulnerability as winter is almost over1. Russia is also a major producer of Aluminium and Nickel and the Ukraine is a significant exporter of wheat. With inflation already elevated this is likely to add to pressure on consumers, particularly in Europe and may prompt a more cautious response from the ECB in terms of raising rates, fearful of further damaging growth prospects.
In terms of our portfolios, we have no direct exposure to Russia or Ukraine and although some of our companies will have operations in the region, it is not a significant proportion of profits. Therefore, from a fundamental perspective, we expect the impact on equity positions in the portfolio will be limited. Russia is also on our red list for oppressive regimes, which precludes investment in Russian sovereign debt.
We had increased cash in our portfolios in Q4 in anticipation of a more difficult 2022 given the likelihood of interest rate rises and inflationary pressures. Reductions were focused on holdings with more elevated valuations and we exited a number of positions where we could no longer justify the premiums. We have remained relatively cautious this year, topping up a few positions such as Starbucks, where valuations have reached more attractive levels and the investment case, in our opinion, remains solid. Our positioning remains focused on what we consider to be quality businesses with high returns on capital, strong profitability and robust balance sheets, all of which should make them well placed to withstand a more volatile macro environment.
The conflict has also resulted in impacts to prices within portfolios which have an allocation to alternatives, albeit to a lesser extent than equities. In the short term, it is likely that the market environment remains volatile and the alternatives will not be immune from this. However, we expect the negative impact on revenues to be low. The alternatives that we hold are comprised of a diversified set of assets including renewable energy infrastructure, music royalties, doctors’ surgeries and logistics warehouses. The drivers supporting the cashflow for these assets and businesses should not be disturbed by events in Ukraine. In terms of investor perception towards these assets, we expect that after the initial shock subsides the defensive characteristics and stable income should prove desirable.
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[1] Bloomberg, 24th February 2022