As we enter the third week of Russia’s invasion of Ukraine, it is astounding to look back at how quickly events have unfolded in less than a month. Since 22nd February, when President Putin announced Russia’s recognition of the independence of two pro-Russian breakaway regions in eastern Ukraine, events have evolved at an exponential pace and the situation is still quickly changing daily.
In all my life, I have never seen any geopolitical event evolve so fast. The conflict on the ground which began on 24th February when Russia launched a full-scale invasion of its neighbour is an absolute tragedy from a humanitarian perspective.
But the invasion on the ground has also turned into an economic one, which has also quickly escalated from the first sanctions imposed on 22nd and 23rd February by Nato countries, US, UK and Europe, against specific individuals close to the Kremlin and a few Russian companies. These sanctions did not materially impact the global equity markets but since Russia’s full scale invasion of Ukraine began on 24th February, the western world has unleashed far more serious sanctions against Russia, cutting off Russian companies and banks from the global financial system.
The shocking impact of these sanctions led to a significant sell-off in the equity markets between 20th and 28th February. But the impacts on the markets have varied.
For example, MSCI’s regional indices show that US markets suffered at the beginning but weathered the storm better than other regions in the latter part of February. Europe suffered much more given its dependence on Russia for gas and other materials, and its geographical proximity to Russia.
The short-term impact of the sanctions has been quite sharp and immediate. Inflation, which was already rising globally, has shot up even further, driven by rising fossil fuel prices, with Russia being a major exporter of oil and gas and many other materials. It's astonishing to see just how the world has underappreciated the dependence it has on Russian exports.
It is often useful to look back through history. As we highlighted in our recent report, Peering through the fog, history shows us that sell-offs driven by geopolitical events have historically been, for the most part, short-lived. That is why trying to time the markets and position for geopolitical events at this stage in the crisis may be a fruitless attempt. Instead, we think investors should keep a cool head and not overreact.
We do not know whether the current state of markets will be short-lived or long-lived. The uncertainty associated with this crisis and its incredibly fluid nature means that the tail of possible outcomes is so wide and, therefore, challenging to predict.
There are also a lot of second-order effects that we do not yet fully know the impact of, and these will play out in the coming months and years.
The second-order economic effects of Russia’s invasion of Ukraine may not actually follow history’s examples because today we live in a very different world – one that is globalised, interdependent and interconnected. Secondly, before this invasion started, there were already severe supply shortages and rises in inflation as the world emerged from the coronavirus pandemic.
There are also many discussions, especially in Europe, about the longer-term impact the invasion will have on acceleration of decarbonisation plans, given that the West’s dependence on Russian oil and gas is hurting. In the coming years, this could lead to a faster move towards self-sufficiency rather than importing fossil fuels from other countries.
There can be a tendency for investors to panic when faced with severe geopolitical crises and react to short-term effects.
At Mercer, we believe near-term understanding is important. However, considering risks and opportunities in the longer term is even more vital. This is why it is so crucial that we try to understand what the second-order effects of Russia’s invasion of Ukraine.
We believe it is crucial to maintain close and continuous communication with the underlying investment managers and economists through a robust feedback and governance process – regardless of whether there is a market sell-off or not.
Having continuous communication with managers and a look-through at the portfolio level we believe is important, especially in these times of distress so that investors have full visibility of their portfolios.
No investor is insulated from shocks, of course, but there are ways to reduce the weight of the impact. We believe the key to this is constructing portfolios are resilient against sudden shocks through strategic and dynamic allocations.
There are several strategies that can protect investors against different kinds of shocks in the markets such as high inflation or volatility. For example, a low volatility strategy that explicitly targets downside protection, or infrastructure assets that tend to have inflation sensitivity.
Having diversification at the multi-asset level, but also within the asset class level, can potentially help weather these storms. Blending managers that have genuinely different return drivers gives the opportunity to have some styles or exposures that do well when others are not. That diversification benefit should pay off especially over the longer term – when one piece of the puzzle does not work, the other pieces should.
References to Mercer shall be construed to include Mercer LLC and/or its associated companies.
© 2022 Mercer LLC. All rights reserved.
This content may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Mercer's prior written permission.
Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax or legal implications.
This does not constitute an offer to purchase or sell any securities.
The findings, ratings and/or opinions expressed herein are the intellectual property of Mercer and are subject to change without notice. They are not intended to convey any guarantees as to the future performance of the investment products, asset classes or capital markets discussed.
For Mercer’s conflict of interest disclosures, contact your Mercer representative or see http://www.mercer.com/conflictsofinterest.
This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances. Mercer provides recommendations based on the particular client's circumstances, investment objectives and needs. As such, investment results will vary and actual results may differ materially.
Information contained herein may have been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential, or incidental damages) for any error, omission or inaccuracy in the data supplied by any third party.
Funds of private capital funds are speculative and involve a high degree of risk. Private capital fund managers have total authority over the private capital funds. The use of a single advisor applying similar strategies could mean lack of diversification and, consequentially, higher risk. Funds of private capital funds are not liquid and require investors to commit to funding capital calls over a period of several years; any default on a capital call may result in substantial penalties and/or legal action. An investor could lose all or a substantial amount of his or her investment. There are restrictions on transferring interests in private capital funds. Funds of private capital funds’ fees and expenses may offset private capital funds’ profits. Funds of private capital funds are not required to provide periodic pricing or valuation information to investors. Funds of private capital funds may involve complex tax structures and delays in distributing important tax information. Funds of private capital funds are not subject to the same regulatory requirements as mutual funds. Fund offering may only be made through a Private Placement Memorandum (PPM).
Not all services mentioned are available in all jurisdictions. Please contact your Mercer representative for more information.
Investment management and advisory services for U.S. clients are provided by Mercer Investments LLC (Mercer Investments). Mercer Investments LLC is registered to do business as “Mercer Investment Advisers LLC” in the following states: Arizona, California, Florida, Illinois, Kentucky, New Jersey, North Carolina, Oklahoma, Pennsylvania, Texas, and West Virginia; as “Mercer Investments LLC (Delaware)” in Georgia; as “Mercer Investments LLC of Delaware” in Louisiana; and “Mercer Investments LLC, a limited liability company of Delaware” in Oregon. Mercer Investments LLC is a federally registered investment adviser under the Investment Advisers Act of 1940, as amended. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Mercer Investments’ Form ADV Part 2A & 2B can be obtained by written request directed to: Compliance Department, Mercer Investments 99 High Street, Boston, MA 02110.
Certain regulated services in Europe are provided by Mercer Global Investments Europe Limited and Mercer Limited.
Mercer Global Investments Europe Limited and Mercer Limited are regulated by the Central Bank of Ireland under the European Union (Markets in Financial Instruments) Regulation 2017, as an investment firm. Registered officer: Charlotte House, Charlemont Street, Dublin 2, Ireland. Registered in Ireland No. 416688. Mercer Limited is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 984275. Registered Office: 1 Tower Place West, Tower Place, London EC3R 5BU.
Investment management services for Canadian investors are provided by Mercer Global Investments Canada Limited. Investment consulting services for Canadian investors are provided by Mercer (Canada) Limited.