Analysis | March 4, 2022
The Impact of War
Capital at risk. The value of investments and the income from them may fall as well as rise and is not guaranteed. Investors may not get back the full amount invested.
Putin’s attack on Ukraine is having wide-reaching consequences for global financial markets as investors reconsider their options
The last few weeks have been tumultuous for global financial markets as the West unites against Vladimir Putin over his invasion of Ukraine. As the world tries to assess the unfolding situation, the financial, economic and humanitarian impact is being felt by global investors and corporates as well as the Ukrainian and Russian people.
The increasing geopolitical risk led to a material change in our extra-financial risk assessment. While we have held a significantly underweight position in Russian assets, we took the decision to remove all exposure to Russia.
The market has been relatively illiquid for Russian assets, yet we believe the unpredictability of the situation has increased the likelihood of being unable to sell these positions later; even if they were to default, there may be no market to sell them at a de minimus price. We expect there to be more sellers as other investors take a similar stance, given the cloud of uncertainty and taint of sovereign aggression, and we expect the buyer base and market makers in these bonds to shrink even further.
Liquidity in Russian related names has virtually disappeared. We wanted to take advantage of what little liquidity remained on the belief that it would dry up as soon as shorts were covered. This concern is now materialising and may intensify as banks withdraw from transacting in Russian names, index providers exclude Russian securities and few-to-no buyers step in to take the other side.
As investors we are in an unprecedented situation. To date, sanctions have been put in place on Russian companies including banks, technology, aerospace and defence companies. Meanwhile the G7 have restricted the Central Bank of Russia (CBR) from deploying its international reserves and disconnected select Russian banks from financial messaging system SWIFT. As a result, the ruble has plummeted and the CBR has more than doubled interest rates.
Rating agencies Moody’s and Fitch have joined Standard & Poor’s in downgrading Russia’s sovereign credit rating to ‘junk’ on concerns the impact of sanctions would leave Russia unable to service its debt.1 At the same time, index providers are considering removing or have have already removed Russian equities from their indexes.2
Oil prices have reached an 8-year high.3 While many nations have so far tried to avoid sanctioning Russian energy companies, demand for Russian oil has waned. Western companies are also cutting ties to the country across industries including technology, entertainment, automobiles and textiles. The Russian consumer is now faced with interest rates at 20%, a weakening currency and rapidly dwindling access to Western goods. 4
Food prices are also being affected, notably wheat, with Ukraine and Russia being primary producers. While the conflict is already sending food prices higher, we are unlikely to see the full impact of the conflict until later in the year.
Alongside the cost on human life, there is also the environmental impact from conflict, with the destruction of urban infrastructure resulting in gas and water leaks and water contamination, the destruction of cultural landmarks and the terrifying possibility of nuclear disaster. Once a conflict is over and rebuilding begins, there is also a knock-on effect on natural resources as demand for raw materials surge.
Germany has refused to certify the Nord Stream 2 gas pipeline, which many have welcomed from an environmental as well as geopolitical perspective - it was predicted to add 100mn tons of CO2 into the atmosphere on an annual basis. 5
While Russian gas is still being sent to Europe, gas prices have soared as speculation intensifies that coal-fired plants may need to increase operational capacity to meet demand should Russian gas supplies fail.
With the greater move towards improving environmental, social and governance standards in portfolios (with more funds being classified as Article 8 under the European Union’s Sustainable Finance Directive 6) the ethics of holdings companies such as Russian oil and gas producers in the current geopolitical environment has become increasingly questionable. At the same time, other ESG-based organisations such as the UN Principles for Responsible Investment are looking at what the situation means for their signatories.
At this stage, second and third order impacts are difficult to assess. Previous supply chain issues that we have already experienced due to Covid, climate change and climate adaptation could be exacerbated. Inflation, already a concern, is likely to rise further or at least remain elevated for longer. Higher oil, gas and commodity prices are likely to broadly impact corporate fundamentals as operating costs rise, putting margins under pressure.
Companies such as global auto manufacturers that sell cars in Russia, and telecommunications operators that have offerings in Russia, could also be hit. Even though these companies are typically well diversified across various geographies, they have already shown significant volatility due to the impact of the crisis on their operations. As such, we continue to assess the situation and the impact on the holdings across our portfolios.
The humanitarian impact of this war can only scarcely be imagined with a whole population's life having been upended, normal life stopped in its tracks and one having to worry about the safety and survival of children and family.
We wish for a swift end to this unfolding tragedy and peace to be restored. In the meantime, we will continue to focus on seeking out good companies with solid fundamentals that we believe will be able to service their debt, while doing our utmost to preserve our clients’ capital.
1. Bloomberg, as of 3rd March 2022
2. Reuters, as of 3rd March 2022
3. Trading Economics, as of 3rd March 2022
4. Central Bank of the Russian Federation, as of 28th February 2022
5. CNN, as of 23rd February 2022
6. SFDR: Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector.
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of October 2021 and may change without notice.
Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.
This material and the views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity; they are for information purposes only. Opinions and statements of financial market trends that are based on market conditions constitute our judgement as at the date of this document. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. Certain information contained herein is based on data obtained from third parties and, although believed to be reliable, has not been independently verified by anyone at or affiliated with Muzinich and Co., its accuracy or completeness cannot be guaranteed. Risk management includes an effort to monitor and manage risk but does not imply low or no risk
This discussion material contains forward-looking statements, which give current expectations of the Fund’s future activities and future performance. Further, no person undertakes any duty or obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Muzinich makes no representation or warranty (express or implied) with respect to the information contained herein (including, without limitations, information obtained from third parties) and expressly disclaims any and all liability based on or relating to the information contained in, or errors omissions from, these materials; or based on or relating to the recipient’s use (or the use by any of its affiliates or representatives or any other person) of these materials; or based on any other written or oral communications transmitted to the recipient or any of its affiliates or representatives in the course or its evaluation of Muzinich.
United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.
Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2022-03-04-8132