The Ukraine Crisis

 The situation in Ukraine is horrific.  We have been moved by tragic events reported in the daily news and encouraged by a spirit of unity among NATO allies – perhaps, even a sense of increased common ground among political parties here in the U.S. 

 

Attacks by Russian military forces on Ukraine on February 24, 2022 have triggered a geopolitical crisis not seen since the second world war. Steps taken by the United States and its NATO allies include severe economic sanctions and other financial measures. Broadly speaking, these steps are intended to apply pressure on the Putin regime by crippling the Russian banking system, its financial markets and its economy. While Russia is at war militarily, the U.S. and its NATO allies are at war economically.

 

Many believe it is unlikely that these steps will motivate the Putin regime to ease aggression or engage in meaningful diplomatic negotiations. This is troubling for several reasons:

 

  • If Ukraine can continue to defend itself, Putin will exacerbate Russia’s pariah status.
  • Prolonged conflicts are never popular and containment of social media, alternative news sources and other information may become more difficult to censor.
  • Desperation, “false flags”, misinformation and other measures could result in reckless actions that could widen the conflict.
  • The more invested Putin becomes, the more difficult it may be to find an “off ramp”.
  • As of March 14, 2022, some estimate the damage to Ukraine has already exceeded $120 billion dollars and the immeasurable toll on human lives is likely to get worse.
  • Even if a peace agreement is eventually reached, it is unclear how the Putin regime will save face through the eyes of the world or have its actions be justified in any way.

 

In response to these events, global capital markets are exhibiting increased volatility.  Out of protest and/or concern about portfolio values, investors want to understand their exposures to Russian and Ukrainian securities.

 

The short answer is that the consequential and systematic risk of this geopolitical crisis is far more material than the typical country-specific exposure observed within a broadly diversified investment portfolio or geographically specific investment fund.

Here are some facts and estimates to consider as reported by Morningstar as of February 28, 2022:

Observations:

  • The direct risk of Russian equity exposure resides primarily in Foreign Equity portfolios and, in particular, the Emerging Markets portion of that portfolio.
  • Many index managers will have zero or virtually zero direct Russia equity exposure.
  • Many active managers will have zero or very low direct Russia equity exposure.
  • Emerging Market index and actively managed portfolios will likely have the most direct Russia equity exposure; however, these direct exposures are very low.
  • When we consider the dilutive effect of diversification through asset allocation, a typical balanced “60/40” portfolio may have approximately 0.08% of direct Russia equity exposure (e.g., 2% of 20% of 33% of 60% is 0.08%).
  • While indirect exposure to Russia from multinational corporations can be more difficult to assess, we believe that consequential and systematic risk will remain first order concerns.

Long-Term Perspective

Market volatility was signaling in 2022 prior to Russia’s invasion of Ukraine. Fueled by the Omicron variant, surging inflation, anticipated rate increases by the Fed and an end to fiscal stimulus, markets were dealt another uncertainty from a major geopolitical event. Times like these require a steady hand and disciplined approach to investing. Again and again, trying to time market swings in an advantageous manner is widely considered a fool’s game. Further, history suggests that staying invested usually pays off as depicted by the following chart. Bull market periods of economic expansion tend to be longer than Bear market periods of economic retraction. Dramatic short-term market declines are often followed by dramatic short-term market recoveries. Missing the recovery can anchor losses and impair portfolio recovery.

 Consider the performance of the S&P 500® Index for the periods February 5, 1964–February 26, 1966 (Vietnam War); July 5, 1990–July 28, 1992 (Gulf War); April 3, 2001–April 28, 2003 (Afghanistan War); September 3, 2002–September 27, 2004 (Iraq War); August 6, 2013–August 31, 2015 (Crimean Crisis) as shown to the right (Source: FactSet and Bloomberg).