Keeping a cool head in the face of chaos and uncertainty 

There is a tendency for investors to panic and react to the short-term impacts of a shocking geopolitical event like the Russian/Ukrainian invasion. But it is vital to keep calm and think about the long-term.

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 24^th February when Russia launched a full-scale invasion of its neighbour is an absolute tragedy from a humanitarian perspective. 

The economic invasion is escalating

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.

Keep cool and think long term

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.

How to weather the storms

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.