With the Ukraine crisis escalating, our multi-asset team provide a fresh update on what the conflict means for investors.

It has been just over a week since Russia invaded Ukraine; for those with direct links to the region, it must feel like a lifetime. Our thoughts are with all those caught up in the conflict.

Although the crisis has dominated the headlines, the immediate impact on diversified multi-asset portfolios has been limited. We noted in our previous update the limited size of the Russian economy and stock market, so while these will suffer the effects of economic sanctions in the months ahead, there is likely to be little direct impact on global stock markets.

As is to be expected in a risk-off episode such as this, investors have pushed up the prices of relatively safe fixed income assets. This is despite the fact that the greatest impact of the conflict will be on inflation. Crude oil prices are up over 20% on where they stood on the day before the invasion and natural gas prices have risen by 9%. These will impact heating and transport costs, but with natural gas used extensively in nitrogen-based fertilisers, food prices are likely to rise too. What is more, Russia and Ukraine make up about a third of global wheat exports and a fifth of global corn exports. Together, the two countries produce just under half the world’s sunflower seeds – in fact, the sunflower is Ukraine’s national flower and has become a symbol of solidarity in recent weeks. Supplies of all of these will be restricted in the months ahead, leading to price increases.

Supply chains

We could also see an uptick in the supply issues experienced late last year. Many German car manufacturers rely on parts produced in Ukraine; with these parts no longer forthcoming, Volkswagen has already been forced to temporarily close factories and, according to the Wall Street Journal, furlough 8,000 workers. Meanwhile, the closure of European Union airspace to Russian planes and the tit-for-tat response from Moscow, together with the blocking of land transport routes, will also cause headaches. In the first half of 2021, over 300,000 containers were shipped by rail from China to Europe, via Russia, according to the WSJ. Sea-shipping bottlenecks will have seen even more freight travelling this route since then. Freight forwarders will now be scratching their heads trying to find yet another solution.

Interest rates

The heightened inflation risks will put central banks in the spotlight. The US Federal Reserve, the Bank of England and the European Central Bank all have rate-setting meetings in the next few weeks. The consensus view seems to be that the current uncertainty will make them slightly less hawkish than before. Rates will still rise, but perhaps at a slightly slower pace. This may provide respite for the beleaguered growth stocks that bore the brunt of the sell-off in January. US equities – with a high concentration of growth stocks – are up over 4% since the conflict began.

Markets

Markets had sold off in the run-up to the invasion, but since then, returns have actually (for the most part) been positive. Measured from the day before the invasion (23 Feb), in local currency where relevant:

MSCI All Country World+2.23%
S&P 500  +4.10%
FTSE 100-0.60%
MSCI Europe ex-UK-2.71%
FTSE World Govt Bond Index+2.08%
WTI Crude Oil+20.96%
Natural Gas+9.05%

Political reaction             

We are not political analysts, but it seems clear this conflict will shape policy in many areas for years to come. Joe Biden is facing mid-term elections this year and needs to keep the cost of living down; this will influence the US decision about sanctions on oil and gas flows. NATO countries will need to step up their defence budgets, but where will they find this money? Will we see a return to deficit financing? China has its eyes on Taiwan and will be carefully recalibrating its strategy in the light of the swift and serious sanctions imposed on Russia already.

Another aspect has been the reaction of individual companies imposing their own sanctions. Spotify, Oracle, Apple, H&M and a host of other companies have reduced services or cut ties with Russia in the past few days. ESG (Environmental, Social, Governance) has been a hot topic in recent months and we are seeing companies put their principles into practice. These companies recognise their social obligations. They are putting this responsibility ahead of profits and are likely to be rewarded by investors for doing so.

Portfolio activity

We have not changed our positioning in response to the Ukraine crisis. Portfolios were already well placed for higher inflation, with fixed income exposure biased towards short duration assets, which are less sensitive to interest rate moves. We have modest overweight positions in the UK, which has relatively high exposure to oil and gas companies benefiting from the higher commodity prices, and to banks, which should perform well in the higher interest rate environment. We are also overweight in Asia: China is attractive given its loosening monetary policy, when most of the developed world is tightening. The macro-economic data within Asia is generally positive and inflows look to be turning a corner. Supply chain easing will have a positive impact on export economies, such as Taiwan and South Korea.

Of course, there is a heightened sense of risk at present, but investing in a diversified, risk-appropriate portfolio is likely to stand investors in good stead in the long term.

Sheldon MacDonald, Chief Investment Officer of Multi-Asset

Risk Warnings
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These are the author’s views at the time of writing and may be subject to change. These opinions should not be construed as investment advice. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our fund of funds range invests for the long-term and may not be appropriate for investors who plan to take money out within five years. The funds will be exposed to stock markets. Stock market prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The funds have significant exposure to bonds, the prices of which will be impacted by factors including; changes in interest rates, inflation expectations and perceived credit quality. When interest rates rise, bond values generally fall. This risk is generally greater for longer term bonds and for bonds with higher credit quality. The funds invest in other currencies. Changes in exchange rates will therefore affect the value of your investment. The funds may invest a large part of its assets in other funds for which investment decisions are made independently of the fund. If these investment managers perform poorly, the value of your investment is likely to be adversely affected. Investment in other funds may also lead to duplication of fees and commissions. Shares may not be redeemed otherwise than
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This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. The Cells referred to are a cell of Marlborough International Fund PCC Limited (the ‘Company’), a protected cell company incorporated in Guernsey and authorised as a Class B Collective Investment Scheme under the terms of the Protection of Investors (Bailiwick of Guernsey) law, 1987, as amended. Investment may only be made on the basis of the current Prospectus, this can be found on the website www.marlboroughinternational.gg. Marlborough International Management Limited is incorporated in Guernsey. Registration No. 27895.
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