Russia and Ukraine: What investors might do and what we are actually doing

The primary investment challenge of the humanitarian crisis occurring in Ukraine is that the unending disturbing images coming to us daily strike a deep chord with our fundamental behavioral biases. In short, we feel the need to do something. Should you do something? If so, what? Fight or flight?

The broad economic backdrop is that we're still in the later recovery part of the economic cycle, where we are enjoying significantly above-trend growth. There are clear risks, as my colleague Andrew Pease shared with you in a blog post earlier this week. This already bad situation runs the risk of moving from primarily a geopolitical crisis to a macroeconomic one. That is currently not our base case—nor it would seem, the market's base case—but there are three clear paths we see to a macroeconomic crisis:

  1. Military escalation of the event
  2. A virtual cyber-war attacking critical infrastructure in the West
  3. Energy uncertainty leading to higher and higher prices

At this point, the situation remains largely contained, which is often the case with these types of geopolitical events. In large part, we think this is the most likely course. Some key observations from today:

  • The invasion by Russia is evidently not going as planned for President Vladimir Putin, and perhaps indicates a more limited ability to militarily escalate outside of Ukraine.
  • An even further increase of cyberattacks by Russia is a primary concern of ours, but highly unpredictable in terms of targets.
  • Natural gas continues to flow freely between Russia and Europe, and that level of co-dependency increases the stakes of either party calling an end to this flow. It's still very possible but perhaps much less likely.

What might investors do?

The problem with doing something is that you need to have fairly specific idea of what is going to happen. And it is important to be right.

  • If you are sure that the situation will remain contained and eventually resolved in some way, then the economies of the countries directly involved are not big enough to pose a macroeconomic threat by themselves. In that case, given the current macroeconomic data, you probably should add risk to your portfolio.
  • If you are sure one of these escalation paths will manifest and turn this into a true macroeconomic crisis, then you should de-risk your portfolio.

You better be right, though. If you're investing based on such a binary level of certainty and you go either way and are wrong, depending on how far you moved, there will be money lost.

What are we actually doing?

At Russell Investments, we continue to maintain overall portfolio risk positioning in our strategies, and we are discussing the potential to add risk. At this point, sentiment is negative but not yet truly panicky (as we saw in March 2020). We are watching sentiment indicators very closely, as any decision to incrementally go risk-on at a model-portfolio level will require a strong signal from that part of our process. With energy pricing increasing uncertainty around the strength of the cycle, the risk-on bar is even higher this week. We are working with our managers to understand how they are thinking about these issues and how they may be repositioning their portfolios.

We are mapping out our strategies around how we will be winding down our holdings in Russia, given the fact that it is not a functioning capital market. Currently, nothing can be done as the markets for these securities are closed.

The bottom line

Our current view of the most probable outcome is that the global economic cycle will effectively weather this geopolitical storm, although risks to this are mounting and recessionary risks may be rising from unusually low levels to more normal levels. Current asset valuations do not scream out a buy-low opportunity. The economic cycle is strong, but there are increasing risks. And although sentiment is negative, we believe it is not so negative as to be sending a strong-buy signal. It is not the most comfortable position to be in, but sometimes the hardest and best thing to do is to stand your ground. Geopolitical events of this magnitude present many challenges—foremost among them, their unpredictability. We will continue to closely monitor events and manage our strategies to the changing conditions.