Russian invasion of Ukraine:
What does it mean for the capital markets?
After the Russian attack on Ukraine, stock prices are falling worldwide and government bonds are experiencing high demand. Investment Strategist Dr. Andrea Siviero provides an assessment and our portfolio managers explain how they have prepared their portfolios for this situation.
The global economy finds itself in a particularly dangerous juncture. Exceptional policy support engineered by policymakers around the world helped the global economy to exit the pandemic-induced recession of 2020. The economic recovery has been unusually rapid and particularly strong and the sharp increase in aggregate demand could not be matched by an unpaired supply.
Inflation has been rising globally in 2021 and central banks in advanced economies have recently signaled a sharp hawkish pivot and accelerated the unwind of their pandemic policy support. The environment of persistent high inflation and softening economic growth is however particularly worrisome and has given rise to suggestions that the global economy may soon enter a period of economic stagflation.
The decision of Vladimir Putin to attack Ukraine will not only cause immense damage to the Ukrainian people and the Ukrainian economy and could trigger the outbreak of a broad and destructive armed conflict in Europe but hugely increase the downside risks to the global economy.
The conflict in Ukraine, together with the ensuing US and European sanctions increases pressure on commodity and energy prices, and will cause slower economic growth. The global economy is hit by a combined supply and demand shock that will weaken economic growth and further intensify inflationary pressures.
The region involved in the conflict (Ukraine and Russia) is one of the main sources of raw material of all kinds: oil, gas, grain, minerals, metals, etc. A sustained spike in energy and commodity prices will feed into price pressures with considerable risks of inflation becoming entrenched, triggering longer lasting second round effects.
With inflation stubbornly high, softening economic momentum and policymakers starting to withdraw policy support, an exogenous stagflationary shock of this sort is particularly worrisome and extremely challenging for policymakers trying to start their normalization process. It represents an important hurdle to the global economy equivalent to a significant foreign tax to growth for the western economies.
How will policymakers react? While the situation is heterogenous across regions and it may be too early to draw conclusions, fiscal and monetary authorities will likely have to carefully reassess their normalization plans. The aggressive tightening policies currently discounted by markets may well have to be revised down and adapted to the new reality. The path to an economic soft landing in advanced economies is still open but risks have increased considerably, and we reacted accordingly by reducing risks and implementing a more cautious approach in our portfolios.
Our portfolio managers explain how they have prepared their portfolios for this situation
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Our portfolio managers explain how they have prepared their portfolios for this situation
In view of the increased volatility on the capital markets, the Ethna-DEFENSIV has already been gradually reducing the risks in the fund since the beginning of the year. The equity quota was reduced to zero early on and the spread risks on corporate bonds were reduced by focusing on high-quality companies and selling riskier assets. As a result, the average credit rating of the bond portfolio has again improved significantly from between A- and A to between A and A+. Overall, the share of high-yield issuers is below 15%, and there are no corporate bonds with a CCC or lower rating in the portfolio. This provides stability and should allow the Ethna-DEFENSIV to come through the current geopolitical crisis well.
After a further escalation in the Russia-Ukraine conflict this morning, we extended the duration again by buying 5% US government bonds and increased the US dollar quota from just under 10% to 20%. Safe investments will continue to be highly demanded due to the high level of uncertainty. Until the political situation has eased or a better assessment of the situation is possible, the Ethna-DEFENSIV remains conservatively positioned for the time being.
The Ethna-AKTIV stands for active and flexible asset management with a capital preservation character. In line with this, the combination of deteriorating growth prospects and a gradually escalating geopolitical crisis on the European border prompted the portfolio management at an early stage to gradually implement risk-reducing measures in the portfolio. Currently, the Ethna-AKTIV has a defensive stock portfolio with a net equity exposure of just under 20%. Of the 54% bonds in the portfolio, 23% are high quality corporate bonds and 31% are government bonds, which should benefit in the "risk-off" environment. With controllable spread risks and a modified duration of 4.1, we believe the fund is well prepared for a more volatile market phase. There is no exposure to Russia or the affected border regions, neither on the equity nor on the bond side. The 43% US dollar quota also has a stabilising effect in this crisis.
With the sum of these measures, we are putting value preservation in the foreground in this environment. Beyond that, however, this is the prerequisite for maintaining the ability to act and to be able to seize opportunities again in the further course of the year.
As the escalation of the Ukraine crisis happened, the portfolio of the most offensive of the three Ethna Funds, the Ethna-DYNAMISCH, strategically continues to focus on the equity markets. However, the investment ratio has been gradually reduced and the hedging components strengthened over the past months. The net equity exposure was recently just below 50 %. There is no direct exposure to Russia and the affected border regions, neither in the fund nor within the portfolio companies. In addition, there is only a very limited weighting in economically more vulnerable cyclical stocks.
In the current very uncertain environment, the reduced equity portfolio in the Ethna-DYNAMISCH is currently offset by a significantly increased cash position with around 20% direct cash holdings, 15% cash replacement in short-dated AAA bonds and 10% indirect cash via equity hedges. Against the backdrop of structurally rising interest rates and recently widening risk premiums, traditional bonds are still not allocated to the portfolio. The overall rather defensive positioning of the equity-focused multi-asset fund is rounded off with a small position in gold.
HESPER FUND - Global Solutions*
The spectre of stagflation is getting closer fuelled by the escalation of Ukraine conflict and the consequent toll in commodity prices. Higher inflation and slower growth lie ahead. The HESPER FUND - Global Solutions did not expect this scenario at the beginning of the year, but has permanently adjusted the portfolio accordingly as the conflict evolved.
Keeping a cautious stance, the HESPER FUND – Global Solutions has been reducing exposure in certain assets such as equity indices and HY bonds and increasing the exposure to commodities since the outbreak of the geopolitical tension between Russia and the west. In addition, the fund has rebalanced the remaining equity exposure (25 %) in favour of non-European regions. With regard to the currency allocation, the HESPER FUND – Global Solutions increased the exposure to the US dollar to 37 % and kept a significant 15 % exposure to Swiss Franc. Further 10 % diversification into currencies of commodity producing countries such as Canada is planned. In addition, gold weighs for 6.5 % of the portfolio.
Unfortunately, a further escalation of the conflict took place as of this morning and an improvement of the situation is not in sight for the time being. As Russia started military operations in Ukraine to defend Donbass and China refused to condemn Russia for the intervention, we are afraid that an oil barrel trading over $ 100 is something that may last longer than we expected.
With the current positioning of the HESPER FUND – Global Solutions, we believe the fund can cushion the impact on the portfolio of current geopolitical tensions.
*The HESPER FUND – Global Solutions is currently only authorised for distribution in Germany, Luxembourg, Italy, France, and Switzerland.
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