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WAR IN UKRAINE | HOW TO STAY TRUE TO YOUR LONG-TERM INVESTMENT STRATEGY IN LIGHT OF SHORT-TERM VOLATILITY

by | Apr 1, 2022

“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioural discipline that are likely to get you where you want to go.”
 Benjamin Graham

Global capital markets received a significant jolt in late February and into March following Russia’s invasion of Ukraine. Western governments have responded with severe economic sanctions on the Russian state and key individuals, aimed at isolating Russia from global capital flows and forcing the Kremlin to retreat. Commodity prices have surged on the anticipation of widespread supply disruptions. Brent crude oil is subject to severe price volatility, soaring as high as US$139 per barrel – the highest in more than a decade – and up from about US$90 at the start of February. Natural gas has surged, while agricultural products – particularly grains – have also leaped in price, given Ukraine’s significance to that market.  This in turn has added to inflationary pressures at a time when growth prospects are softening.

Taking note of the above, it’s only natural for investors to question their investment strategy. To say that the first quarter of 2022 has been volatile is a stunning understatement. Year to date, markets have been tossed back and forth by speculative headlines regarding the potential for Russia to invade Ukraine. With the potential invasion having become a reality, the S&P 500 has fallen into a correction for the first time in two years, joining the Nasdaq Composite (a correction is defined as a drop of more than 10% but not more than 20%).

We appreciate that whilst these kinds of events are not new, the volatility and uncertainty it causes doesn’t make it any easier for investors to deal with.

Given the recent and expected continuation of market volatility throughout 2022, Victoria Reuvers, MD of Morningstar SA, has highlighted some of the lessons we should turn to when trying to think and act long term:

  1. The long run is just a collection of short runs you have to put up with.

Long-term thinking can, to some extent, be a deceptive safety blanket that investors assume allows them to bypass the painful and unpredictable short run. Unfortunately, this is very rarely the case. As can be seen in the below graph, the opposite scenario normally plays out – the longer your time horizon, the more calamities, geopolitical events, inflation scares, tech bubbles, great depressions, financial crises and disasters you’re likely to experience.

The reality is that part of long-term investing is dealing with short term pain, and you will need to embrace downturns throughout your investing journey. Annual return and drawdown data of the S&P 500 show that – although over the last 42 years we only ended up with an annual negative performance in 9 out of the 42 years – every single year (in the 42 years) had a drawdown or temporary setback in the market, and each of those for very different reasons.

  1. The importance of building robust portfolios

The most powerful protection against market volatility and uncertainty is diversification within portfolios.  Both the Morningstar S.A. and Global Managed Portfolios have been constructed to ensure exposure to areas of high conviction whilst maintaining diversification across different regions, sectors and asset classes.

  1. Zooming in on the regional exposure of the global portfolios

Russia has very small equity exposure in the global indexes, making up only 3.2% of the MSCI Emerging Markets Index and only 0.4% of the global stock market (measured by the MSCI AC World Index). Ukraine has no exposure in either index. When we consider the Morningstar Global Managed Portfolios (Global Cautious, Global Balanced and Global Growth) these portfolios have limited exposure to Russian Equities (less than 1% at the high end).

Whilst the human cost of military action is immeasurable, the stock market reaction to an invasion of Ukraine may be similar to those of the past with little quantifiable impact for well-diversified investors.

How are we reacting to the threat of a downturn?

Victoria goes on to emphasise that the portfolios are being proactively managed and tested against various scenarios that could play out.  Should investors be worried about potentially higher inflation, the global portfolios hold sectors that will benefit from higher inflation such as commodities, energy and high-quality defensive companies with pricing power. If the concern is a sell-off in US markets, the portfolios are underweight the US and they have allocated to attractively valued parts of the market that include the UK, Europe and Japan. If the concern is a prolonged invasion of Ukraine, the portfolios are diversified across regions with a small position to direct Russian equities.

As we move through this latest period of market volatility, Morningstar Investment Management’s 90-strong investment team continue to prioritise research into overreactions, digging deeply into the risks and opportunities presented by the 500+ asset classes they cover to identify those that are unusually attractive or unattractive. Alongside this, the portfolio managers are continually testing the portfolios by simulating different scenarios to ensure that they remain robust to a broad range of potential economic outcomes rather than simply those that dominate the headlines today.

We encourage investors to take the approach of navigating this unknown territory with caution, to diversify smartly, focus on the long term and pay careful attention to valuations.