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Close to Home: Investing implications of Russia’s War on Ukraine

I have family in Kyiv as well as in Belarus. Although I left my home country of Belarus two decades ago, what is happening there hits very close to home – and for many of my family hits at home. The unprovoked and brutal assault on Ukraine by Russia is a human tragedy on a scale Europe has not seen since WWII. I fear the worst is yet to come in terms of human suffering, both in casualties and shattered lives and livelihoods.

The financial fallout for investors holding Russian assets has been enormous as well. How did Russia end up in this place and what can investors learn from it?

Clearly, this is a catastrophic governance failure of the Russian government. Until now, investors’ governance focus has been at the company level, but our eyes are now open to the devastating impact of failure at the state level. The fallout is so much broader and far-reaching when malfeasance occurs at the top echelons of government.

I see three primary contributing factors to Russia’s governance failure: groupthink at the highest levels of the Russian government, empire-building to further Putin’s personal view of the world order, and corruption advanced within Ukraine by the Russian leadership. Much has been written and said about the first two factors. 

The third factor is less well-publicised.

Reportedly, Russia has been spending billions trying to corrupt Ukrainian politicians to build pro-Russia sentiment. The billions spent appear instead to have backfired. Both those doling out the billions and the recipients hugely exaggerated their achievements. The narrative Putin likely heard from these factions further mired him and his lieutenants even deeper into groupthink.

Bond market hangover: Investors must ‘ignore the noise’

As an investor, what can you learn? What can you do?

First, consider the possibility of governance failure in other nations. A prime example is China, which may be following in Russia’s footsteps, encouraged by groupthink and a desire for empire building. Although China lacks a formal multi-party system, two factions of the CCP had traded power roughly every ten years. Xi Jinping has worked diligently to remove constraints on his staying in power and to weaken the competing factions. 

Like Russia, China lacks an independent media as well as restraining institutions to protect against catastrophic governance decisions. Media coverage in China about the war in Ukraine has been anecdotally pro-Russian. It may signal a desire to promote a strongman mentality, normalise the use of force, and lay the groundwork for force as a means of solving the ‘Taiwan question’.

Think carefully about your exposure to China – both directly and indirectly.

Second, clearly, even without the pressures emerging from the sanctions on Russia – likely a fact of life for a long time to come – and the renewed assaults on the global supply chain, inflation is the number one problem today for investors. Look for inflation protection across the spectrum of alternative assets.

Third, look for long-term opportunities. Value sectors in the US, UK, and Europe – especially oil and natural gas companies set to gain from yet higher prices in the future – are still very attractively priced. Value stocks tend to be more cyclical and to even benefit from higher inflation.

Fourth, diversification is key. If nothing else, the recent geopolitical developments have underscored the value of a diversified portfolio. 

Vitali Kalesnik is director of research at Research Affiliates

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