Asset managers are grappling with the impact of tougher sanctions on Russia after its invasion on Ukraine which are wreaking havoc on the country’s economic and financial system.
Rating agency Fitch has announced that 10 Russia-focused and emerging market investment funds with assets under management (AUM) of €4.2bn have suspended redemptions.
Fitch thinks that further Russia-focused funds may suspend redemptions – also known as gating – because they can’t trade portfolio securities. Other emerging market funds exposed to Russia may also be temporarily unable to trade certain Russian securities, it added.
Some emerging market funds have a Russian exposure for up to about 25% of AUM and the funds with higher exposure to Russia “will be more likely to implement extraordinary liquidity measures” than those with a lower exposure, Fitch said.
Some funds that have direct exposure to Russian entities may put in place swing pricing to make redemption costly, Fitch said in a statement, adding that it is aware of two fund groups that have implemented swing pricing to their emerging market and Russia-focused funds so far.
According to investment management data from Lipper, European mutual funds with a focus on Russia had a total AUM of close to €5.7bn at end-January 2022, and emerging market funds had a combined AUM of about €640bn with roughly a 4% exposure to Russia on average.
Fitch’s rated European funds do not have a direct exposure to Russian entities, as of the end of January, but the rating agency is continuing to monitor the situation closely for signs of unexpected spill-over effects.
Direct and indirect impacts of sanctions
For Paul Jackson, global head of asset allocation research at Invesco, the direct impacts of the sanctions on Russia include “restrictions on trading in Russian assets, to which must be added the banning by Russia of the sale of its assets by foreigners”, he told IPE.
However, most investors have limited exposure to Russia that accounted for a marginal part of global equity and bond indices, although the weighting in emerging market benchmarks is bigger and currently of the order of 1-2%, depending upon the index provider and the asset, he said.
Secondly, “volatile markets tend to be less liquid, so current uncertainty may make it more expensive to transact in most financial assets across the world [and] finally, there is always the risk that sanctions imposed on Russia could bring unintended consequences within the financial system, with the possibility of defaults that could spark contagion effects”, Jackson explained, adding that central banks will stand ready to provide liquidity if needed.
“Invesco’s policy is to fully comply with all US, EU and UK sanctions that are imposed as a result of Russia’s further challenges to Ukraine’s sovereignty and territorial integrity,” he said.
The Russian invasion of Ukraine and the subsequent sanctions can turn some markets into a difficult territory for investments.
“The conflict will lead to spill-overs to emerging markets. For example, the shares of companies exporting products to Russia, for example Brazilian protein companies, sold-off last week as higher wheat and corn prices increased, while the sanctions disrupted sales,” Ashmore’s head of research Gustavo Medeiros said.
Russia and Ukraine are, however, relatively small markets for most emerging market countries, making the “trade linkage impacts mild”, he added.
The indirect consequences of the sanctions on Russia, according toJackson, include “the negative effect on the rouble and the value of Russian assets; those exposures are clearly much lower than at the start of the year because of the fall in value”.
“More important to most investors will be the knock-on effect on the value of non-Russian assets due to the economic consequences of those sanctions and Russia’s response to them,” he added.
For instance, he explained, the lack of ability to export to Russia will dampen the economies of trade partners and this will have an effect on profits and equity valuations. This effect is most likely to be felt in Russia’s neighbours and in the broader European economy. But the most serious effect would result from Russia retaliating by cutting energy supplies to Europe.
“It is hard to see how Europe could avoid recession were that to happen [..] this could push Europe into stagflation because the resultant economic disruption would cause product shortages which could add to inflation,” Jackson said.
The European Union and its allies have imposed further punitive measures on Russia, targeting the country’s central bank after cutting domestic banks from the international payment system SWIFT.
As of yesterday, the EU Council approved a ban on transactions with the Russian central bank in response to the crisis in Ukraine. This ban is “the real hammer”, said Jonathan Hackenbroich, policy fellow for economic statecraft at the European Council of Foreign relations in Berlin.
”Russia’s Central Bank might struggle to fight massive inflation and panic even after it doubled interest rates and introduced capital controls,” he said.
“SWIFT sanctions added to the pressure in the short term and sent a big political signal,” he added.
An official at a top 10 asset manager in the DACH region, who wished to remain anonymous due to the sensitivity of the situation, said that “it is impossible to trade Russian securities and also settlements are impossible”.
The asset manager has a low exposure to Russia and it has not seen redemptions so far. “The problem with redemptions is that it is difficult to calculate the net asset value of a fund without stock exchange trading,” he added.
The Russian central bank has closed the Moscow stock exchange to contain the consequences of the sanctions.