Ukraine-Russia sector considerations: Asset management

Investors and asset managers around the world have had to rethink their investment planning practices as a result of the ongoing conflict in Ukraine. With geopolitical shifts, there’s a need to reevaluate the approach and practices to withstand uncertainty and strengthen portfolios — while taking into consideration the implications of how money is invested.

The crisis in Ukraine has resulted in trading restrictions and bans that have impacted investors’ outlooks on financial markets across the globe. It’s important that those in the asset management sector consider their direct and indirect exposures to the impacts arising from the conflict and to identify what aspects are potentially material and require further evaluation.

With a limited exposure to Russian assets, global fund managers face the impact of market volatility, rising prices, hedging, sanctions and challenges from changes in globalization. 

It has become increasingly clear that organizations, their clients and the broader public are trying to do the right thing. Fund managers and asset owners are debating whether holding Russian assets is in line with their personal values — reflecting on whether their environmental, social and governance (ESG) philosophy is aligned with domestic demands and their investment choices. What’s more, many prominent investment funds have been vocal and are actively reducing their Russian investment exposure.

Further sanctions and regulatory changes are expected — likely at speed. Clients should remain close to their stakeholders and monitor their ecosystem meticulously. Contracts with sanctioned businesses or Russian clients more generally may need to cease. As foreign business owners sever commercial ties in Russia, it’s likely that disputes will arise on terminating contracts and protracted legal proceedings will increase.

To be clear, it’s important that leaders in this sector be careful not to view this conflict as an opportunity to benefit from crisis and the volatility that accompanies it.

There has been an increase in cyber threats for financial institutions — putting their operational resilience to the test and challenging business continuity. The scope of this risk extends beyond the obvious hack of tangible assets such as money, equity and bonds — it’s also about exploiting data and disrupting the status quo.

Organizations should take the time to understand their preparedness to fend off a cyber-attack. The impact of these attacks on business continuity must be considered because it has the potential to dictate whether a business has the ability to be up and running.

But this risk is broader than just attacking systems and protecting data. Countries will also need to be prepared for an attack in the event it extends to an easier target — critical infrastructure such as energy, solar power and wind farms. Those who are unprepared to weather the storm are setting themselves up for future volatility.

The geopolitical situation in Eastern Europe has had a ripple effect — creating disruption in the fixed income, interest rate, foreign exchange, commodity, and equities markets.

Since the conflict began, stocks have witnessed sharp and fast volatility in prices. The market pivoted to crisis-management mode — where the equity market sold off and bonds witnessed diminishing returns. Some emerging market funds have a higher Russian exposure, and those funds are more likely to implement strong liquidity measures, than those with a lower exposure. In the short term, the effect of price volatility in the market is a reminder to have sufficient safety cushions in your portfolio. While the long-term effects are still unknown, the likelihood of lower valuations is increasing.

While trading on the Moscow Exchange resumed in March 2022, the government of Russia has imposed restrictions on foreign investor activity. The Russian financial system was hit by a raft of new sanctions including the removal of some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), global payments system and restrictions on the Central Bank of Russia to deploy foreign reserves. The shutdown of Russia’s stock exchange has led to suspension of subscriptions and redemptions, as asset managers are unable to calculate the net asset value of funds.

Drastic changes in market inputs are impacting many types of financial instruments, which has caused fair value implications for valuations. The absence of an active and liquid market creates significant challenges. Fund managers are grappling with how to fairly value Russian securities in their portfolios. When leverage is involved, debt covenants could be breached as values decrease significantly, requiring refinance — if possible.

This will also create deal opportunities with investors looking to offload their investment holdings, debt and equity interests in these assets. With a decrease in market activity in Russia, valuation is a real challenge, and many investors are making use of penny stocks amid a highly unpredictable market.

As globalization continues to change, there’s a lot that could be reassessed and repriced in the asset management industry, which creates further caution and uncertainty into valuations.

With indexes rebounding, attention is shifting to the rise of inflation. The conflict is likely to increase inflationary pressure by further disrupting supply chains and raising commodity prices that may lead to hard economic landing.

Investors and asset managers with high cash equivalent holdings are likely to be more impacted as government policies to alleviate the current crisis will probably prove inflationary — ultimately declining the real value of cash accounts.

People will continue to pour money into pensions, inflations bonds and asset swaps. Inflation is going to be a big issue and the responses of central banks on interest rates will likely have wider reaching growth and inflationary impacts.

The Russia-Ukraine conflict continues to disrupt markets across the global economy and how entities are affected continues to evolve. The scope largely depends on the nature of uncertain events such as additional sanctions and the reactions to constantly changing financial markets. In the short term, it’s critical that global asset managers remain in constant communication with their stakeholders and consider factors such as reputational risk, cyber threats, fair value implications, market volatility and looming inflation pressure. And there’s a need to develop plans for today and tomorrow to protect and strengthen portfolios.