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
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
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.
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.
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.
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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