Investors battle with volatility, inflation while repositioning assets following sanctions

Investors are dealing with nerve-wracking events after the start of the war in Ukraine with rising volatility and inflation while trying to reposition portfolios by selling Russian assets as sanctions cut off the country from the international financial architecture.

The escalation of the conflict in Ukraine has already marked an increase in volatility, with credit spreads for investment grade, high yield and peripheral euro bonds continuing to widen as equity markets were on the path of further correction, Amundi’s chief investment officer Vincent Mortier and deputy CIO Matteo Germano wrote in their global view for March on the implications of higher inflation and geopolitical tensions on the markets.

While inflationary pressures mount as the European Central Bank (ECB) plans to scale back quantitative easing, geopolitical risks remain very difficult to assess, and a further escalation of the conflict is likely to put further pressure on the market.

Annual inflation in the euro zone hit a record high of 5.8% in February, up from 5.1 % in January, with energy prices rising 31.7%, said Eurostat, the statistical office of the European Union, yesterday.

“Investors should continue to try to benefit from the recovery primarily by picking selected stocks, but be prepared for the worst, for example adjusting their hedges to counteract a possible further deterioration of the situation,” it said.

With inflation getting a further boost, investors should opt in the medium-term for value/quality equities, while Amundi has become “more cautious” on bonds given rising liquidity risks and a less attractive risk/reward profile compared to equities, Mortier and Germano added.

Volatility is, meanwhile, increasing across the board in bonds, equities, commodities, currencies, and the investment landscape looks riskier than it did a month ago, they added, but growth should remain solid this year.

The big risk is a possible spill over of the conflict between Russia and Ukraine, which could have a significant impact on the prospects for growth and inflation, and “this is the key point for investors to keep in mind,” they added. Commodities prices continue to rise and the price for the brent crude oil went up to close to $118 (€106) a barrel for the first time in almost a decade.

Traditional European investment managers are likely to feel the indirect impact of market volatility, Fitch stated, adding that resulting risk-aversion could lead to net outflows from open-ended funds with investors turning towards less risky, more liquid strategies.

In the short term alternative asset managers can navigate volatility better than traditional investment managers as their funds are mostly closed ended, limiting outflows, and fee arrangements are “locked in and largely based on committed or invested capital,” it said.

But a prolonged period of market decline would deteriorate the environment for fundraising and investments, with managers holding material seed investments or co-investments on the balance sheet that would be exposed to a decline in valuations, it added.

Repositioning assets

Requests for redemptions from private banks may increase as a result of sanctions but modestly compared to the firms’ overall net client flows and assets under management, it added.

Fitch announced this week that 10 Russia-focused and emerging market (EM) investment funds with AUM of €4.2bn suspended redemptions and Amundi had also suspended three equity funds with exposure to eastern Europe despite only 0.1% exposure to Russian assets.

Union Investment has suspend the issue and redemptions for UniEM Eastern Europe fund because the Russian stock market, on which a significant part of the fund’s assets are officially listed or traded, is currently restricted to foreign investors, and as a result it is impossible to dispose of a large part of the investments and to ensure exact calculation of the value of the unit in the fund, it said.

The UniEM Eastern Europe had around €100m at the end of January, and around 60% invested in Russia. As soon as these restrictions are lifted, Union will reverse the measure taken, it added.

“In the global emerging markets funds UniEM Global and UniRak Emerging Markets, [instead], the holdings in Russian securities were insignificant even before the escalation [of the Ukraine-Russia conflict] on 23 February, they were in the low single-digit percentage range, [while] significant commitments in Russia are in UniEM Eastern Europe [fund], therefore we have taken measure,” a Union spokesperson told IPE.

Russian government bonds have been excluded from Union’s ESG Publikumsfonds for some time and investments in Belarusian government bonds are already excluded for all retail funds.

For all the other actively managed mandates, Union has decided to prohibit the purchase of all securities of the Russian state and of a number of Russian state-related issuers. The ban covers the primary and secondary markets and applies until further notice, the spokesperson added.

“Further steps cannot be ruled out in principle in this heated situation. The non-Russian stocks in the [Union Investment] funds are managed actively in order to achieve appropriate results for the investors in this situation,” he said.

Pension funds also reacted to the escalation of sanctions against Russia, cutting investments and, as in the case of Pubilca in Switzerland, factoring in a stagflation scenario in the asset and liability management.

Credit Suisse is overweighting EM in the global equity strategy, with EM currencies sufficiently cheap against the US dollar, the lender said in an analysts’ statement, adding that it focuses on China and Mexico, upgrading Brazil to overweight. It is instead reducing the overweight in European equities whose outlook has darkened, it added.

Index provider MSCI has meanwhile announced that it has removed Russia stocks from its emerging markets indices, reclassifying them to the status of standalone markets.

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