March 23, 2022
The daily escalation of the war in Ukraine is tragic, and the range of potential outcomes is unsettling. We are seeing a devastating humanitarian crisis and the human toll is immeasurable.
Below we speak to some questions we have received and provide insights into how we are currently managing portfolios.
Emerging market risks
Russia is one of a group of countries investors call ‘emerging markets,’ which reflects the stage of maturity and development of their economies and financial systems. Collectively, companies in emerging markets are an attractive source of growth for investors, despite their heightened risks. Stock markets in the developed world have comparatively low return expectations resulting from developed markets’ lower economic growth and higher valuations. Our emerging markets strategy had a 2% weight to Russian stocks coming into the crisis. When considering this in the context of clients' overall portfolios, this equates to less than one-tenth of one percent. Client portfolios have no exposure to companies in Ukraine.
What impact has the war had on portfolios?
While direct exposure to Russian and Ukrainian assets is minimal, portfolios have not been immune to the volatility of the past few weeks caused by the war. Russia and Ukraine are important countries in the supply of commodities. Russia supplied approximately 12% of world oil and about 38% of Europe’s natural gas until the start of the war. Additionally, Russia and Ukraine--known as the breadbasket of Europe--provided roughly 25% of the world’s grain. Since the war began, commodity prices, particularly oil and gas, have shot up, acting like a tax on the global economy. This will put downward pressure on economic growth in many regions.
Context is key
It is important to understand the global economic landscape that was in place before the onset of aggression. The world was experiencing inflation levels not seen in decades, exacerbated by commodity underinvestment and global supply disruptions caused by the COVID-19 pandemic. Economic growth was riding high, boosted by the massive fiscal stimulus to offset COVID-19-related demand weakness. Central banks began their efforts to slow the economy and inflation by signalling higher interest rates are coming. At the start of the year, it appeared the peak in growth was behind us, but there was more to do to fight higher prices. This environment tends to lead to more market volatility as investors assess the impact of higher rates on the economy and securities. Even before the war, the global equity market had already experienced a correction, falling 11%.
The R word
A cocktail of higher interest rates, slowing growth and spiking commodity prices increases the risk of a recession and consequently more downside price movement. We believe it is too early to determine if a global recession is likely. However, when we look at history, we see that periods of interest rate rises and commodity price spikes often lead to recessions. It explains the volatility in recent weeks. Investors are rightfully fretting because the risk of a recession has risen materially, particularly in Europe, which will be hit hardest by higher energy prices. Canada is less affected, given we are a net energy exporter.
How we are managing portfolios through this period
We lowered client portfolios’ equity exposure over recent quarters, and, as important, we significantly reduced global equity positions in favour of Canadian stocks. Canada offers good growth prospects, underscored by strong commodity prices and attractive valuations. Bond prices have fallen substantially in the past six months but still offer only modest returns, especially after accounting for inflation. We continue to believe corporate bonds and our Private Client Multi-Strategy Portfolio offer more attractive opportunities for investors in their fixed-income allocations.
Within the equity allocation, our portfolio management teams have been reducing exposure to cyclical areas of the market. This positioning is the result of the economic environment, which has been strong but slowing. Lastly, private market investments, including real estate, infrastructure and private loans, are performing well. We believe they will continue to do so.
Maintain a long-term view
Market declines can be unsettling but regardless of the flow of news, at some point asset prices will recover. Those who remained invested through these events have historically come out the other side better off. While we cannot predict the short-term outcome of the conflict in Ukraine, we are well positioned to manage portfolios through the stresses and strains of this period with high quality assets in client portfolios.