Even if you aren’t glued to various economics news sources like me, you probably heard about Russian securities
markets in the past month. Or the ruble, or whether Russia will default on their debt. It would be natural to wonder how that might be affecting your own investments. As always, we encourage readers to focus on long-term goals and not fret over daily market fluctuations. That said, here are our comments.
Before the conflict began, Russia was classified as an “emerging market” for investment purposes. That lies between “developed markets” (France, Japan, Canada) and “frontier markets” (Bangladesh, Iceland, Kenya) (1). These classifications are based on the securities markets of each country, not just their economy. To be considered a developed market, a country is evaluated “based on MSCI’s market classification framework that assesses economic development, size and liquidity, and market accessibility.” Note that size in itself is not a factor – Belgium is clearly smaller than Russia or China, but the former is in the “developed” category.
Ukraine is classified as a “frontier” market by MSCI and not classified by FTSE, and thus would not appear in most broad market funds. Even MSCI’s “All Country World” index excludes the frontier market countries, for several reasons. These markets are difficult to trade efficiently, and the funds are too large to hold an appropriately small portion of the companies in the markets.
So if you held an emerging markets index fund, or an “All Country World” fund, before the invasion, you probably had a small amount of exposure to Russia. Our flagship ESG strategies hold ESGE (iShares ESG Aware MSCI EM ETF), which as of the fund’s 8/31/2021 annual report, held 3.6% of its assets in Russian securities. The conventional EM fund SPEM (SPDR Portfolio Emerging Markets ETF) held 2.7% as of 12/31/21. (3)
If you held active funds that included Russia in their investment universe, you may have had more or less exposure than an index fund. Some investment managers focusing on natural resources might have had a higher weight, while those interested in the “emerging middle market consumer,” a phrase often heard about China, may have had less or none. Or managers may have included Russian securities because they seemed inexpensive, or excluded them due to governance concerns. Since our investment philosophy excludes active funds, we don’t monitor them closely, but we’re happy to help clients who have such a fund in their portfolio take a closer look.
Figure 3: iShares ESG Aware MSCI EM ETF 2021 Annual Report
Figure 4: Country weights, SPDR Portfolio Emerging Markets ETF, Fact Sheet as of 12/31/2021
After the Invasion
As you likely heard, Russia closed its securities markets the day after its invasion of Ukraine, after a rapid fall in prices. Index providers and fund managers had to value the relevant securities at zero, since they couldn’t be sold. Unfortunately for investment performance, funds lost whatever value those securities represented previously. This is yet another example of why diversification and allocation are both so important.
MSCI has since announced that they will remove Russia from the Emerging Markets categories and relevant indexes, and give it “Standalone Market Status.” This status means that while the country didn’t move along the developed/emerging spectrum, it doesn’t fit well in those categories anymore. Argentina is another example of such a market – it was reclassified last year due to constraints the country had imposed on international investors. So going forward, most index funds that held Russia previously will probably not hold it in the future, but it’s important to look carefully at the fund description to be sure.
Companies in other countries have also been affected by the events in Ukraine, and this is often reflected in their share prices. European companies dependent on Russian natural gas would be an example. This indirect exposure to Russia is much harder to quantify at the fund level, but given the decades-long globalization trend, it seems unlikely that any well-diversified portfolio is entirely free of it.
We can’t predict the future of this conflict or securities markets, of course, but we do expect anything short of a drastic turnaround in Russia’s strategy to result in ongoing volatility.
In the face of the huge destruction, loss of life, and threat to autonomy in Ukraine at present, it may feel selfish to worry about your investment portfolio. Or investments might not be on your mind at all. Either way, we’re here to help. Reach out if you would like to have a conversation with us.