Geopolitical shocks raise warning flag for investors

Ukraine.

Syria.

Venezuela.

Turkey.

Thailand.

North Korea.

Asset owners and money managers say in an interdependent world, they are used to the drumbeat of geopolitical crises.

Lately, it feels like the beat is getting faster.

The protests in Ukraine that toppled the government of former President Viktor Yanukovych and ultimately led to Russia's annexation of Crimea has put a spotlight on how quickly things can change. The crisis also raises questions for investors about a possible sovereign debt default, the financial health of oil and gas sector companies in the region, and even the strength of the European economic recovery.

Christopher J. Ailman, chief investment officer of the $180.8 billion California State Teachers' Retirement System, said staff always keeps an eye on geopolitical risks when it comes to making global investments.

“The markets are more interlinked now than they were in the 1980s. It's a tougher job than it was 30 years ago, because it's a more dynamic global marketplace,” Mr. Ailman said in a telephone interview. “Difficult to price' is part of investing in the global market.”

Mr. Ailman routinely presents possible geopolitical risks to the CalSTRS' board that he referred to as the “black swan list.”

CalSTRS, West Sacramento, has about $6.3 billion in emerging markets, according to pension fund spokesman Michael Sicilia.

Allianz SE Chief Economic Adviser Mohamed El-Erian, in a commentary last week in the Financial Times, cautioned investors to pay attention to the possibility that the cumulative geopolitical risk from tensions and crises around the globe, including those in Ukraine, Syria, North Korea and elsewhere, could prompt a speedy asset repricing. Mr. El-Erian was unavailable for further comment.

Allen Sinai, CEO of Decision Economics Inc., said in a phone interview that he sees a “one in 10” chance of the situation in Ukraine leading to a global recession and laid out the factors that could do the most harm. Decision Economics is an economic and financial information firm in New York.

“The damage to the full global economy at this point is limited, unless the fight between Russia and the West escalates into a situation that drives oil and natural gas prices significantly higher,” he said, noting that Russia falling into a recession, thereby shutting down its supply of crude oil and natural gas to Ukraine and the U.S., could trigger such a scenario.

Matt Rubin, vice president and director of investment strategy at Neuberger Berman Group LLC, New York, was more positive in a weekly written market highlight released March 24 that the company remains “constructive on equities and anticipate(s) global economic health will improve over the course of the year.”

“Geopolitical tensions, particularly with respect to Ukraine/Russia, are providing a source of noise but we do not believe it is likely to have a significant, longstanding impact on asset class returns,” added Mr. Rubin. Mr. Rubin was unavailable for a phone interview.

Neuberger Berman has $242 billion under management, of which $5.5 billion is in dedicated emerging markets equity and bond portfolios.

Although some are speculating that Russia's military action against Ukraine could be the start of a new Cold War, the geopolitical crisis does not appear to faze many long-term investors and industry experts, as many are always planning for there to be some global crisis somehow or somewhere.

This is not to say they are completely unconcerned. Some believe the annexation of Crimea by Russia is very different from the geopolitical crises the world has seen in the past 10 years.

Sabine Konrad, a partner in the Frankfurt office of international law firm McDermott Will & Emery LLP, said: “Because there is no U.S.-Russia investment treaty, U.S. investors have to be extremely careful. U.S. investors should consider restructuring their investments now, before any Russian intervention, to be protected by investment treaties of other countries.”

In terms of how the situation in Eastern Europe will affect emerging market debt, the International Monetary Fund announced March 27 that it will provide the Ukraine with up to $18 billion in assistance in the next two years.

Marco Santamaria, portfolio manager for emerging markets debt at AllianceBernstein LP, New York, said how the IMF handles the Ukraine situation will be an important marker for investors to find out how much risk they're taking when they buy sovereign debt.AllianceBernstein manages $231 billion on behalf of its institutional clients. (AllianceBernstein's emerging markets multiasset portfolio has net assets of $248.57 million.)

Mr. Santamaria noted it's still too early to tell how this situation and its impact on the global economy will unfold, since “we don't have a good sense of how far sanctions are likely to go against Russia, and we don't know what Russia's response will be to these sanctions.”

“The note (from the IMF) is clearly positive for Ukraine bonds,” said Steffen Reichold, portfolio manager and emerging markets economist at Stone Harbor Investment Partners LP, New York. “It looks like it addresses some of the demands the IMF has had for a long time, such as raising gas prices and addressing the fiscal deficit, so it's certainly positive news.”

Stone Harbor has $62.5 billion in AUM, with $52 billion in emerging markets.

“Russia is a big player in Ukraine's economic forces. It may have many tools at its disposal to undermine the economic stability of Ukraine, so those risks are still quite high and we're paying close attention to how that situation evolves,” Mr. Santamaria added.

Linda Duessel, senior vice president and senior equity strategist at Federated Investors Inc., Pittsburgh, said situations like the one developing in Ukraine won't drastically affect asset pricing or long-term investing. Ultimately, she said, global stock markets boil down to two factors: “corporate earnings; and the price we're willing to pay for those earnings.”

“I don't know how this will all play out. We probably won't get back to the 28.6 (price-earnings ratio) that we had in 2000. So I'm not expecting euphoria,” she added. “But we still will invest.”

Federated has $3.4 billion is in global equities and $1.8 billion is in global fixed income.

“I'm hoping diplomacy will prevail with this particular incident,” said CalSTRS' Mr. Ailman. “The U.S. market's reaction has been fairly muted and reasonable.” n