Fund Positioning in Light of Russia’s Invasion of Ukraine

Due to the Russian invasion of Ukraine, on the 24^th February, we have to consider its effect on financial markets, and the economic sanctions against Russia and Belarus.  A regional war in Europe has an outsized material impact unless it can be viewed as an isolated impact with little change of contagion. 

This war is a short-term impact.  Now is not the time to panic and sell equity just as we are on the cusp of a global recovery.  The markets have already weathered heightened geopolitical tensions in the past, and two years of a global pandemic.  Looking back in similar points of such tension in history, equity has tended to recover after a period of bear with positive 1-and 2-year returns.  Such volatility in markets, particularly when unrelated to the long-term economic realities of fundamentally-strong investment, should be as potential opportunities. 

Additionally, global growth and company earnings are likely to remain strong this year while monetary policy normalisation will be more gradual than what many market participants have projected.  This is largely due to the immediate impact of sanctions.  On the contrary, current market volatility offers an excellent opportunity for us to increase equity allocation at a discount.  None of us can confidently call when the market will bottom out.  This means it would be prudent to execute a strategy of gradual increase in equity stakes of select funds.  The macroeconomic outlook does not change.  There will be a disconnect between the underlying worth of the market and their price.  Now is the time to take advantage of that dislocation. 

Here are some facts to consider in light of sanctions, so there is some perspective.  Russia accounts for around 13% of global oil production, and 17% of global natural gas production.  This makes Russia the largest single producer of energy in the world.  As such, the conflict has raised natural gas prices.  Oil prices regained the US$100 mark for the first time since 2014.  The spike in energy prices has compounded broader inflationary concerns that have troubled financial markets.  There will also be an impact on other commodities such as wheat because Russia is the world’s largest exporter, and Ukraine is one of the world’s largest exporters.  Russia’s invasion of Ukraine will fuel a rise in inflation.  Sanctions will make it worse.  This complicates central bank decisions on interest rates and monetary policy. 

In light of this, where do AIA funds stand?  All AIA ILP funds have limited exposure to the energy sector.  AIA Elite Funds and AIA Global Dynamic Income have less than 1% exposure to Russian and Ukraine securities while the rest of other ILP Funds either do not have any direct exposure or have negligible exposure to Russian and Ukraine securities at the time of writing.  Neither Russia nor Eastern Europe have been central to our investment strategy. 

We have had 2 years of the Covid-19 pandemic.  Global recovery has since been strong on the back of unprecedented liquidity and significant policy support from major central banks.  2020 was extremely volatile because it is unprecedented in modern finance.  2021 was seen as a year of recovery.  Major indices saw double-digit returns; the MSCI World index rose 22.3% and US S&P 500 rose 28.7%.  Vaccination programmes and easing of lockdowns further spurred global growth.  There was a spike in consumer demand for goods resulting in strong corporate earnings.  This fed higher inflation and strengthened the labour market. 

Since 2022, inflation is well above the Federal Reserve’s target of 2%.  The American consumer price index rose 7% in December 2021 from a year earlier.  This is its fastest pace since 1982.  As such, the Federal Reserve was already expected to take more aggressive action to curb surging inflation.  The Federal Reserve’s current quantitative easing asset purchase program will end by March 2022 as they taper purchases.  There will then be a likely balance sheet reduction, leading to a reduction in the nearly US$9 trillion in assets the Federal Reserve is holding .  Of that US$9 trillion, around US$8.3 trillion comprises of Treasuries and mortgage-backed securities.  The expectation that the Federal Reserve would engage in triple policy tightening has shaken the market on worries of an economic slowdown.  The markets are concerned because it is uncommon to have the Federal Reserve taper so rapidly, lifting interest rate, and reducing its balance sheet simultaneously.  Previously, these actions were taken with intervals in between so that the market can adjust. 

In anticipation of this, AIA Elite Funds are well diversified across a combination of global equities and global fixed income funds.  Asset allocation decision remains one of the largest drivers when determining the range of outcomes.  Underlying allocation of funds are monitored and reviewed on a regular basis.  Adjustments are made accordingly to best position the fund to capitalise on opportunities ahead.  These opportunities have been outlined above, and in previous articles. 

Consider this: During the onset of Covid in 2020, it was recognise that certain stocks will benefit the Elite portfolio from the lockdown and working from home.  Our fund managers anticipated that change in consumer behaviour.  They, therefore, increased exposure to the Growth strategy fund that Baillie Gifford sub-manages.  Since November 2020, Covid-laggards, value and cyclical stocks, have caught up to growth stocks, which vastly benefitted during Covid.  In view of this, our fund managers increased exposure to a more value-style tilt, and rebalanced the factors exposures within multi-factor equity funds.  As the Federal Reserve continues to tighten and real rates trend upwards, its high correlation of value-over-growth outperformance is implies more upside to value.  We should expect such trends to continue well into 2022.  At the beginning of 2022, our fund managers increased our exposure towards value. 

Our investors, with an extended investment horizon, are expected to reap value as we ride the recovery wave expected.  The situation in the Ukraine does not have a lasting impact on our portfolio due to negligible exposure.  Our only concern is inflation, and the measures to address them.