Russia-Ukraine Crisis: Managing a sudden shock with potentially long-lasting effects

The Russian decision to invade Ukraine came as a shock to the financial markets, as the consensus was that it was very unlikely.

Our range of emerging market funds, as well as Carmignac Sécurité and Carmignac Patrimoine, reflected this consensus view, as our managers considered that the situation had reached its peak. As we do in all circumstances, we initiated those positions from a long-term perspective, based on both financial and extra-financial considerations.

The sudden rise in tensions led us to reduce our Russian and Ukrainian exposure before the offensive. Nevertheless, the dislocation of the Russian market did not permit us to liquidate them completely in conditions that would have guaranteed the interests of our clients. While most of our Russian equities were sold, some bonds remained in the portfolio, with partial hedging.

At the time of writing, they represent 1.5% of assets for Carmignac Sécurité and 2.4% for Carmignac Patrimoine¹. These percentages represent the maximum additional potential losses.

(1) 1.4% for Carmignac Portfolio Sécurité and 2.3% for Carmignac Portfolio Patrimoine

We manage with conviction, driven by an ethic that we translate into our investment policy.

We have therefore decided not to purchase any Russian securities until further notice.

Meanwhile, we are committed to optimize the exit of securities still present in the portfolios, taking into account extra-financial aspects as well as market conditions, in order to preserve the interests of our clients, our primary objective.

The world economy is facing a triple shock.

The first is affecting international trade with disruptions in energy but also food commodities, metals, fertilizers and air cargo. The second is an uncertainty shock with the collapse of the post-Cold War geopolitical order along with the risk of escalation. Finally, the third is a financial shock, with potential defaults by Russian and Ukrainian entities and contagion risk to other countries.

The Russo-Ukrainian conflict and associated economic sanctions induce a stagflation risk, i.e. an inflationary economic slowdown. The scarcity of available commodities could lead to major disruptions in supply chains, which would have a negative impact on growth but a positive impact on prices.

While the economic outlook for 2022 was already pointing to a slowdown in the pace of growth and resilient inflation, this conflict is amplifying economic trends that we had incorporated into our investment strategy.

Effects of slowing growth and accelerating inflation will affect Europe and Asia more than the United States. Indeed, the main macroeconomic spillover effect comes from commodity prices, to which the European Union is more vulnerable given its dependence on oil and gas imports.

Making assumptions on the degree of escalation in the conflict, both militarily and economically, we have simulated a range of plausible scenarios and assessed their consequences for Europe and the United States.

The negative impact on European growth would range from -0.5 to -2%, with an impact on inflation of +1.1 to +1.7% on a full year basis. For the United States, the impact would be lower, with a decline in growth ranging from -0.2 and -0.5%, and +0.7 to +1.2% on inflation.

The identification of stagflationary trends before the conflict led us to adopt a more cautious positioning and to reduce our exposure to risky assets.

On the equity side, our investments, which were overweight in the United States, are now largely concentrated in defensive segments within healthcare and consumer staples and/or in those offering good visibility at reasonable valuations within the information technology and consumer sectors. The proportion of high valuation growth companies has been greatly reduced.

At the same time, the overall net equity exposure of our Patrimoine funds was reduced to around 10%, mainly as a result of index hedging.

In the fixed-income markets, we hedged our bond exposure through protective purchases on the credit and emerging debt markets and opted for positioning to take advantage of tensions on intermediate maturities.

This is a dramatic period for millions of people, mainly Ukrainian civilians and refugees. It is also complex for fund managers and investors. If the adversity it generates was to be prolonged, the defensive positioning of our Funds should allow to limit further adverse impact.

In any event, the return to normality, whenever that may be, will allow our portfolios to benefit from the mechanical revaluation of the most depreciated assets.

We are committed to providing you with timely information, as we have always done. It is on transparency that the most solid relationships are built.