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Stay up to date with our investment views on the Russia-Ukraine conflict

Stay up to date with our investment views on the Russia-Ukraine conflict

03-03-2022 | Vision
In this article we will regularly post updates from the various investment teams. Stay tuned.

Speed read

  • With diplomacy having failed, severe sanctions unlikely to deter Putin
  • Portfolio exposures to Russia trimmed or completely sold ahead of escalation
  • We continue to monitor developments and will make further portfolio adjustments as needed

Some implications for quantitative equity portfolios of the decision by index providers to remove Russian equities

Authors: The Quant Equity Team | Quant Equity
Published: 3 March 2022 | 17:30

Valuation
Robeco is closely monitoring the impact of the trading suspensions of Russian assets for its quant equity funds and will apply fair value pricing as stipulated in the prospectus of the funds. The decision by index providers MSCI and FTSE Russell to remove Russian stocks from their respective indices at a valuation of close to zero provides an important input to Robeco’s current process of fair value pricing of these stocks.

Exposure to Russia
It remains unclear if and when the Moscow stock exchange will resume trading, how long trading bans will stay in place for foreign investors and if there will be continued reluctance among brokers and custodians to facilitate trading. Also, it is still unknown if and when trading of Russian stocks listed on offshore exchanges will commence.

The move by MSCI and FTSE Russell effectively implies that these stocks will become off-benchmark stocks. In general, our quantitative funds are entitled to remain invested in off-benchmark stocks if these meet the criteria of eligible countries and sustainability. Given the special circumstances, we are evaluating whether these Russian stocks should remain part of our fund portfolios once trading resumes.

The overnight collapse of an emerging market
In just seven days’ time Russia has transformed from a respected emerging market constituent to the pariah of global financial markets, thereby impacting the financial wealth of our clients. We regret the negative financial impact of plummeting Russian stocks on our quant portfolios. However, the humans affected by these geopolitical events ultimately bear the real costs.

These recent events remind us how important it is to focus on financial wealth as well as well-being when managing portfolios on behalf of our clients. Given the size of Russia in emerging and global indices and the objective of our portfolios to deliver high absolute or relative risk-adjusted returns, it means that having exposure to these stocks has been inevitable for most portfolios. Therefore, and this accounts for all emerging markets, when selecting stocks we always aim to integrate sustainability dimensions in the best way possible when searching for alpha opportunities. In addition, when managing the portfolio we strive to act as good stewards by actively pursuing a sustainable voting and engagement agenda.

A perspective on the implications for commodity markets of the Russia-Ukraine conflict

Authors: Rob Schellekens | Emerging Markets Equity
Published: 3 March 2022 | 10:00

Ramped up sanctions against Russia have severely weakened the country’s ability to meet its international financial obligations. The drastic measures have prompted a widening of Russian credit default swaps to 1265, a level last seen in 2008-09, and caused the ruble to tumble. Meanwhile, index providers MSCI and FTSE have confirmed the new treatment of Russia. MSCI Russia will be reclassified from ‘emerging markets’ status to ‘standalone markets’, effective after market close on 9 March 2022. FTSE Russia will be removed from all FTSE Russell Equity Indices, taking effect after market close on 4 March.

For now, one area still carved out from sanctions is energy. Russia continues to export its gas to Europe and its oil globally – although the discount on Russian oil is increasing as some countries are banning the purchase of Russian barrels. As it is the single most important source of income into the state coffers, trade in energy remains a lifeline for the Russian government

Besides oil, Russia is also responsible for a significant portion of global production in a number of commodities given its resource-rich landmass. The war has therefore had an impact on the prices of soft and hard commodities, adding to upward pressure on inflation. The impact of sanctions on global supply chains is a further consideration for inflation.

Figure 1 | Russia’s share in global commodity production (%)

Source: J.P. Morgan Commodities Research, 21 January 2022

Other commodity-rich EM countries stand to benefit from this unfortunate situation. South Africa, for example, could benefit given its exposure to gold and platinum-group metals. Certain Latin American countries could similarly benefit, given their resource base. Of course, the opposite is true for commodity-importing countries, who will be hurt by rising prices.

Update from the fixed income investment teams

Authors: The Fixed Income Team | Fixed income
Published: 2 March 2022 | 18:00

The below table reflects the direct exposure of our fixed income funds to Russian and Ukrainian issuers as at the end of February 2022.

Fixed income funds not shown in this table have no direct exposure to Russian or Ukrainian issuers.

Source: Robeco
As at 28 February 2022
Indirect exposures to Russia are possible, for example via issuers that derive part of their revenues from Russian clients, through Russian companies with subsidiaries in other jurisdictions, or via market moves driven by the geopolitical situation. Portfolio managers and analysts continuously assess the impact of such indirect exposure on the qualitative and quantitative investment theses of such issuers.

Our Quant Equities portfolios in the context of the Russia-Ukraine geopolitical tensions

Authors: The Quant Equity Team | Quant Equity
Published: 2 March 2022 | 09:30

The escalating Russia-Ukraine crisis and its impact on equity markets so far
Following the barrage of sanctions imposed on Russia, the accessibility of the Russian market has deteriorated drastically, and the local market has become practically non-tradeable for foreign investors. Today, for a third consecutive day, the Moscow stock exchange remained closed. At the time of writing, foreign investors were banned by Russia from selling Russian securities, and capital controls have been imposed. Meanwhile, the liquidity and tradability of Russian ADRs and GDRs, listed on the London and New York stock exchanges, are rapidly deteriorating.

Despite the turmoil in the Russian onshore and offshore markets, the broader global equity markets have held up relatively well, as shown in Figure 1. The MSCI EM Index, in which Russia currently accounts for some 1.6% (based on Friday’s closing prices), has only declined by around -4.8% YTD as at 28 February, whereas the Russia ADR/GDR posted losses exceeding 75%. However, as the local market is closed and with ADRs and GDRs becoming increasingly more difficult to trade, prices may not truly reflect the situation and accurate valuations may be difficult to obtain.

Figure 1 | Cumulative returns of the major indices up to 1 March 2022.

Source: MSCI. Returns are gross in USD.

Portfolio management and current exposures to Russia
We are cognizant of the market environments in which our portfolios operate. As part of our human overview process, portfolio managers are in the lead to closely monitor and manage any short-term, ad hoc market risks which may not be readily captured by the long-term models. The overarching goal is always to act in the spirit of the models while taking into account the various practicalities to ensure efficient portfolio management and risk mitigation.

In the case of Russia, for Conservative Equity and Factor Investing, we reduced overweight positions to a maximum of 2.5% and implemented a ‘no buy’ rule for Conservative Equities on Russia since mid-December last year. This was to proactively manage active risks in view of the escalating geopolitical tensions in the region. In portfolios with exposures higher than 2.5%, positions were reduced under benign market conditions.

On Tuesday 22 February, we extended the decision to not increase exposure to Russia for all Quant Equity strategies. This included the Core Quant portfolios which were positioned neutrally or below benchmark level. Simultaneously, we continue selling Russian positions in those instances where these sells are triggered by a quant strategy.

Later in the week, on Thursday 24 February, we put a ‘freeze’ on all Russian holdings in our portfolios: due to high market volatility and uncertainty around sanctions, we would not trade these holdings. This decision was extended on 1 March.

Current portfolio exposures

Source: Robeco
Note: The portfolio weight for local shares has been calculated using stock prices as at close of business on Friday 25 February, as the Moscow exchange has been closed since. The ADRs/GDRs in portfolio and the FX rate are valued against prices as at close of business on Monday 25 February. The benchmark consists mainly of local Russian shares, so valuation of stock prices in RUB is as of 25 February, whereas the FX rate is as of 28 February. Against current market valuations (observing the sharp price declines of the ADRs/GDRs) the portfolio weight as well as the benchmark weight would be significantly lower now.

Our Core Quant fund portfolios currently have a neutral or underweight exposure to Russia versus the broader market indices.

The table provides an overview of exposures to Russian stocks for our Quant Equity Emerging Markets funds, as well as the percentage invested in ADR/GDRs.

Looking ahead
We are closely watching market movements as the Russia-Ukraine situation evolves, which is likely to continue weighing on market sentiment.

An update from our fixed income investment teams on the consequences of the Russia-Ukraine conflict for portfolios

Author: Joop Kohler | Aggregate fixed income, Investment grade credits, High yield bonds, Quant fixed income
Published: 28 February 2022 | 16:00

As part of the sanctions imposed on Russia, the United States and the European Union this past weekend agreed to remove some Russian banks from the SWIFT messaging system and to freeze the central bank's reserves. In addition, most of Europe has closed its airspace to Russian carriers. The Central Bank of Russia has more than doubled its policy rate, hiking rates from 9.5% to 20%, and has imposed some capital controls in a bid to shield the economy from sanctions. Rating agencies have reacted; so far some have downgraded Russia to high yield, while others have put the nation on review for downgrade.

Robeco is closely monitoring the developments regarding the conflict in Ukraine and the implications of the sanctions on Russia. We follow all applicable sanctions that the United Nations, European Union and/or the USA impose and follow any mandatory (investment) restrictions deriving therefrom. In general, we take a cautious approach toward investing in Russia, supported by our ESG assessment of the country. While Russia has always had a rather weak ESG score (both in our Country Sustainability Ranking and in our SDG Country Assessment), this has further deteriorated over the past year, reflected among others in declines in the scores for political risk and stability. For quite some time now, this has prompted us to take a cautious stance towards this country. Robeco has no exposure to Russian sovereign debt.

The fixed income investment teams continue to monitor the evolving crisis and will act accordingly by making further portfolio adjustments as needed. Continuous surveillance is in place to identify potential portfolio exposure to securities issued by sanctioned entities. Securities of sanctioned entities are added to our trading and compliance module to assure pre- and post-trade checks. With each update of the sanction lists, our investment teams check if any of the names are part of the fixed income portfolios.

As communicated on Thursday 24 February, the direct exposure to Russian issuers in fixed income portfolios is limited. As of the end of January 2022, we report the following direct allocations to Russian issuers in fixed income portfolios:

Direct allocations to Russia in Robeco Fixed Income strategies

Source: Robeco. As at end January 2022.

Note: The allocations in the table above have declined over the course of February. Fixed income strategies not reflected in this table do not have direct allocations to Russian issuers.

Indirect exposure to Russia is possible, though, for example via issuers that derive part of their revenues from Russian clients, via Russian companies with subsidiaries in other jurisdictions, or via market moves driven by the geopolitical situation. Portfolio managers and analysts continuously assess the impact of such indirect exposure on the qualitative and quantitative investment theses of such issuers.

Comments from fixed income investment teams:

Global Credit Team
The risk profile of fundamentally managed global credit portfolios has been increased as valuation levels started to price in some of the tail risk. To illustrate, the current spread level of the euro investment grade credit market has exceeded its long-term median. Most of the fundamentally managed credit portfolios have overweight exposures to financials, based on the view that banks can act as a good hedge against higher interest rates. However, some banks do have loan exposure to Russia and therefore the portfolios do have indirect exposures, which are being monitored by the portfolio managers and credit analysts.

Global Macro Team
Global Total Return Bonds, Climate Global Bond and Euro Bonds do not hold any direct exposures in either Russia or Ukraine, and the team therefore has not had to make any fundamental changes to the investment positioning in the wake of the conflict. The portfolios have remained cautious on emerging markets more broadly since the pandemic volatility, and have been cognizant of the geopolitical risk relating to the Russia-Ukraine conflict over the last quarter. These portfolios have held a strategic off-benchmark short exposure in a CDX EM index (which includes both Russia and Ukraine) since May 2021. This position has since been closed out. Within FX, a short position in both HUF and PLN has helped the portfolios to withstand any adverse impact on relative performance. With tensions in the Ukraine now having escalated, rates exposures, in our view, could benefit from flight-to-safety demand, and we remain optimistic on the outlook for bonds.

Quant Fixed Income
Robeco QI Global Dynamic Duration invests in developed market government bonds and therefore has no exposure to emerging markets, including Russia and Ukraine. Robeco QI Global Multi-Factor Credits has no direct exposure to Russian issuers. Indirect exposures are being monitored by the investment team as part of the human oversight by portfolio managers and credit analysts.

Assessing the implications of Russia’s invasion of Ukraine for our multi-asset portfolios

Author: Peter van der Welle | Multi-Asset Strategies
Published: 25 February 2022 | 16:00

With markets already jittery on the back of a seismic shift in developed market central bank policy, the recent Russian invasion into Ukraine only stirred volatility further. In the run-up to this tragic event, we adopted a dollar hedge at the end of January as we deemed the Ukraine-related risks underpriced by the market; Russian CDS spreads were just a third of the level observed during the annexation of Crimea by Russia in 2014. We judged that though the odds of invasion looked slim, the impact this time could be much larger, warranting higher risk premiums.

In addition, the dollar has been a positive carry trade and correlates well with Russian sovereign credit spreads. Subsequently we also took profit on our long-standing underweight Treasuries, bringing it back to benchmark neutral. We deemed the abovementioned a sufficient adjustment to the portfolio to cope with the current market volatility. In recent days we felt no urge to chase the market given the geopolitical nature of current risk sentiment, which is prone to overshooting. There are three ways the Russian invasion impacts our multi-asset portfolios: via risk premiums, earnings impact via the FX, inflation and commodity channels and liquidity/financial conditions.

Risk premia already largely reflect risks
Credit spreads and equity risk premia have widened considerably in the last four weeks, with the risky asset sell-off accelerating after Putin’s hour-long speech on 22 February that signaled that near-term invasion risk was increasing. Yet, markets were clearly wrongfooted by the 24 February full-fledged invasion, with the Russian stock market dropping almost 50%. Typically, risk premiums reverse and start to compress once peak economic policy uncertainty has materialized (see Figure 1). With markets usually rallying after uncertainty has peaked, the question is whether we have already seen peak uncertainty regarding Ukraine.

While it is still unclear what endgame that Putin has in mind, his near-term goals have become clearer over the last 24 hours; a regime change through removing the current Ukrainian government and replacing it with a puppet regime like Belarus. The rebound in the Nasdaq on 24 February shows the market expects Putin to get what he wants. In addition, this rebound was fueled by toned-down rate hike expectations as central banks weigh the geopolitical impact on the growth trajectory. Here geopolitical concerns may outweigh the near-term upside risks to inflation as energy prices spike. For instance, ECB’s Holzmann said that the Ukraine conflict could delay the stimulus exit. As concerning as this regime change may be from a humanitarian point of view, it gave markets clarity on Putin’s goals and seemingly less hawkish central banks, which implies we are inching closer to a buying opportunity.

Figure 1 | MSCI World equity returns around peak economic policy uncertainty episodes

Source: Refinitiv Datastream, Robeco

Growth hits a speedbump, no derailment of economic expansion in Eurozone
Europe imports around 40% of its energy from Russia. Apart from the German invasion in 1941, Russia has always respected contractual agreements with Europe and kept gas flowing. It is likely willing to continue pumping gas to Europe today to finance its costly war. Between Europe and Russia there is a sort of economic ‘mutual assured destruction’ (MAD) dynamic at play that inhibits a severe sanctions regime from hurting Russia’s largest export product. Europe needs Russian gas imports as much as Russia needs to export gas to Europe, though in the medium term that may be alleviated by opening of strategic oil reserves, a reinvigoration of coal as energy source and extension of US fracking licenses.

The hit to growth in Europe could be limited as the sanctions so far exempt the all-important energy flows into Europe. In addition, gas reserves are still ample and able to weather potential disruptions to Russian gas supply if Russia were to counter sanctions by closing the taps. Only a disruption that lasts beyond the summer months could be problematic, as replacing Russian volumes by importing LNG would be very expensive or physically impossible.

Nonetheless, producer and consumer confidence will take a hit in coming months, though the Eurozone economic expansion will likely remain intact. The expansion will hit a speedbump but will not be derailed.

Given the fluidity of the ongoing events, estimates of the magnitude and the duration of the Eurozone growth deceleration are subject to high uncertainty. Elevated energy prices erode purchasing power of consumers and dent consumer confidence. The ECB estimates that a 10% gas rationing would hit Euro-area growth by 0.7%. If the Russian gas taps were turned off completely this would imply a hit of 2.8% to GDP growth. In our base case Russian gas keeps flowing, implying only a moderate hit of 0.5% to European 2022 GDP growth. Given the operational leverage of European corporates this would shave off 1% of European earnings growth for 2022. Our view also implies that the risks regarding the current consensus MSCI Europe 12m forward EPS growth forecast of 6.9% are balanced.

Modest tightening financial conditions
Financial conditions could tighten in the near term given the impact of sanctions on capital mobility especially in Russia. Rising equity versus bond volatility also hints at a tightening of financial conditions, though the overall near-term impact should be mild, barring sanctions that exclude Russia from SWIFT. Also, the recent drop in real interest rates suggests a significant worsening in financial conditions is less likely.

Figure 2 | Equity/bond volatility ratio versus financial conditions

Source: Refinitiv Datastream, Robeco

Podcast: Not seeing red on Russian invasion

Published: 25 February 2022 | 15:00

With Russian tanks rolling into the suburbs of Kyiv, what should investors do? Wim-Hein Pals, head of Emerging Markets Equities, talks about keeping calm in a crisis, and the impact the conflict might have on various sectors and regions. Tune in to hear it all.

Chinese and Asia Pacific equities exposure to potential conflict is limited

Authors: Helen Keung, Arnout van Rijn and Jie Lu | Chinese Equities and Asia Pacific Equities
Published: 25 February 2022 | 10:00

As a result of Russia's actions earlier this week, we highlight our latest views and exposure for Chinese and Asia Pacific equities portfolios.

Robeco Chinese A-share and Chinese Equities
We have no direct exposure to Russia and Ukraine in both portfolios.

China imports a large amount of agricultural goods from Ukraine. This, together with the oil spike, could lead to inflation risk. Nevertheless, as China's inflation is currently low, we believe that China can to a large degree absorb the impact of imported inflation.

China is going through an easing cycle while the Federal Reserve is expected to trigger a tightening cycle. For the equity market, Chinese stocks are trading at more attractive valuations, while onshore Chinese A-share equities have a low correlation with global markets.

Robeco Asian Stars and Sustainable Asian Stars Equities
We have no direct exposure to Russia and Ukraine in our two Asia-ex Japan Equities portfolios.

We have exposure in frontier markets in the ASEAN region such as Vietnam. We have been adding exposure in Indonesia recently, which is well-positioned for higher commodity prices. We believe that the ASEAN region is well-insulated from the current conflict and present attractive bottom-up stock-picking opportunities.

In the past months, we increased our selected exposure in the Asia ex-Japan region with attractive valuation and participating in the energy transition for long-term carbon neutrality goals. Our commodities and energy-related holdings benefitted from the recently hiked commodities prices. It could offset some of the negative effects on selected impacted companies created by the current geopolitical development. Furthermore, India as an oil-importing country is generally adversely affected by high oil prices and we have been underweight India for a while due to its high valuation.

Robeco Asia Pacific Equities
We have very limited exposure to Ukraine in the portfolio and no direct exposure to Russia.

We continue to see good earnings growth ahead in Japan. Stocks here have been trading at a valuation discount to its recent history, developed market peers, and selected emerging markets. We will monitor the impact of input prices closely.

The Value style will be underpinned as it is more resilient in case of longer-lasting geopolitical uncertainty. Global investors will reassess the outlook for global growth after the military aggression, which can have an impact on cyclicals. Energy importers like Japan, India and Korea will see inflation rise further in the near term.

The above general views on China and Asia ex-Japan are in line with the that of Robeco Asia Pacific Equities.

Our team is closely monitoring the situation and its impact to specific country and companies in Asia amid market volatilities.

Equity exposure to Russia trimmed ahead of escalating conflict with Ukraine

Authors: Jan de Bruijn and Rob Schellekens | Emerging Markets Equity
Published: 24 February 2022 | 14:46

Putin’s aggression justifies an extremely cautious stance towards equities exposed to the potential fall-out. Our emerging markets equities team continues to monitor the situation closely.

It is currently very difficult to predict how this conflict could de-escalate in the foreseeable future or how severe and far-reaching the sanctions will be. Key will be to see how long and how far this Russian operation continues. Nevertheless, after the recognition of the separatist republics and Putin's speech, we had decided earlier this week to reduce or completely remove portfolio positions in stocks likely to be exposed to the conflict and sanctions.

Our initial assessment of the tensions between Russia and Ukraine had resulted in a base-case scenario in which we expected that diplomacy would prevail, despite all the sabre-rattling. Our view had been that rational minds would prevail, given the potentially severe downside impact to Russia if Putin went ahead and invaded Ukraine. This week has proven our base case to be too optimistic, with Putin clearly demonstrating that the West’s primary deterrence tactic – the threat of severe economic sanctions – may not be enough to prevent the largest war in Europe for decades.

In our country analysis framework, the political and policy analysis has always acknowledged the inherent risks that surround Russia and this, in large part, explains the low valuation given to Russia. These risks are considered in our country allocation as well as our valuation frameworks (including any ESG adjustments) and factor in the imposition of the maximum country risk premium of 2% to Russian valuations. On the plus side, though, Russia has a positive macro standing thanks to its low debt, strong financial power, twin surplus and prudent monetary and fiscal policies. Our Russian exposure takes this into account and reflects the country’s expected risk-adjusted return profile.

That said, the geopolitical tensions with Ukraine, which had been on-going since the annexation of Crimea in 2014, very quickly turned in just a matter of days. Following President Putin’s speech on 21 February, in which he acknowledged the sovereignty of the Peoples Republic of Donetsk and Lugansk, he quickly offered military aid in the form of “peacekeepers”. Overnight, this turned into a special military operation which looks to have the aim of neutralizing the military infrastructure across Ukraine. This is of course a grave escalation of the situation, and we are now awaiting the sanction packages that will be imposed on Russia. We will continue to monitor the evolving crisis closely and will act accordingly by making further portfolio adjustments as needed.

Implications of geopolitical tensions for Quant Equities portfolios

Author: Rob van Bommel  | Quant Equity
Published: 22 February 2022 | 11:00

Our Quant Equity strategies adopt a bottom-up stock selection process to harvest long-term factor premiums without any top-down allocation overlay as driven by short-term market events.

That said, we are cognizant of the market environments that our portfolios operate in. As part of our human overview process, portfolio managers are in the lead to tightly monitor and manage any short-term, ad hoc market risks which may not be readily captured by the long-term models. The overarching goal is always to act in the spirit of the models while taking into account the various practicalities to ensure efficient portfolio management and risk mitigation. After discussing in the human overview committee, portfolio managers may adopt short-term override actions should a special situation occur.

In this case, for Conservative Equity and Factor Investing we have already reduced overweight positions to max 2.5%, and implemented a ‘no buy’ rule for Conservative Equities on Russia since mid-December last year, in order to proactively manage active risks in view of the escalating geopolitical tensions in the region. Portfolios with exposures higher than 2.5% reduced positions under benign market conditions.

“The decision was made today to extend our call not increase exposure to Russia for all Quant Equity strategies, including Core Quant portfolios which were positioned neutrally or below benchmark level,” says Rob van Bommel, Head Quant Client Portfolio Management. “Simultaneously, we continue selling Russian positions if these sells are triggered by a quant strategy. Our team will continue to monitor the Russian situation closely.”

Our portfolios are broadly diversified with tightly managed active positions at country, sector and stock levels, for efficient risk management and mitigation. Currently our Core Quant portfolios have a neutral or underweight exposure to Russia versus the broader market indices. It is also worth noting that a significant portion of our exposure to Russia is accessed via GDR/ADRs listed in New York/London, which could potentially offer more flexibility during times of crisis and sanctions. We expect these ADRs and GDRs to continue trading even if local limitations occur.

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