Ukraine Crisis: DB Wood Performance Update…

As always at times of market stress, we feel it’s important to communicate our views and activities to clients at the earliest possibility. In this respect it is not our first rodeo – the very recent experience of Covid volatility in early 2020 a key example, but we also managed portfolios through 2008 and even back to the Iraq war in 2003. At the same time, its important to recognise that no two environments are ever the same, though we have learnt many lessons over the years in how to navigate them successfully.

On the current situation in Russia and Ukraine, the path of conflict is extremely hard to predict. At the same time, it feels to us that there are significant consequences to the growth, inflation, and interest rate trajectories, irrespective of the degree of escalation.

The most obvious change is further increases to energy costs. At the time of writing Brent Crude Oil is trading over $100 per barrel for the first time since 2014, with natural gas prices in some countries up more than 25% in a day. This will not help the price pressure on consumers, nor their confidence given the negative news-flow we can expect for some time. The UK and US seem better placed than its European counterparts to deal with these changes, however Russia supplies continental Europe with about 30% of its gas, compared to just 5% in the UK. The US is energy self-sufficient, so doesn’t have to worry about higher European prices.

Consumer confidence across the board will be dealt a blow though, having a knock-on effect on economic growth and the path of interest rates. We feel that the conflict should lead to a more careful path of interest rate increases, even in the face of higher energy inflation. To state the obvious, this is quite a significant change from the environment that markets have been expecting. Onto the key questions then…

How are we positioned?

We came into this week with a neutral allocation to equities, having reduced risk into the winter ahead of the Omicron scare. Our core focus remains on quality businesses that we expect to remain as structural winners. We had recently reduced our European equity exposure, and did so significantly once again on Monday morning, adding to both commodities and US equities. We wanted to hedge both the inflation risk and the Russia risk, which so far this week has worked well given the losses in European equities and gains on commodities. For reassurance, it’s also important to say we have no exposure to Russian equities.

Lower risk clients should also be comforted by our government bond holdings. We have persevered with these ‘safe havens’ despite their dislike for inflation. So far this year it has been quite painful to hold these assets as they have been a drag on performance, though as part of a diversified portfolio, we hold them as an asset that will help protect our portfolios in a ‘black swan’ event such as this. Additionally, whilst being sterling based, our portfolios do hold a reasonable exposure to the dollar and the yen, both of which have lost ground to the pound so far this year, though have gained this week as investors search for ‘safe havens’. Along the same lines, our gold exposure also tends to perform well in risk-off periods such as this.

Now whilst we are happy with the diversification of our portfolios, that is not to say we expect the portfolios to gain in value given the falls in markets generally. However, we do expect to perform well on a relative basis, giving us opportunities when the right time comes.

What will we be doing moving forward?

Despite the forward geopolitical landscape looking very uncertain, we remain of the view that over the long run this market correction will be looked back on as an excellent opportunity for long term returns. Our experience shows that in the vast majority of scenarios where an event is not born from an economic issue, markets rebound well, usually within 6 months of the crisis. In this respect there will be a time and a place to add equity risk and benefit more as markets recover. Timing that will be an important challenge, though we will use all our experience and resources to do that as best we can. For now, we remain cautious and positioned for further volatility, though as we’ve stated often before “you make most of your money in a market drawdown, you just don’t know it at the time”.

We will keep you updated along the way with our thoughts, and rest assured, our investment team are fully focussed on navigating the challenges to the long-term benefit of clients.