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The party is over for the Russian gangster state, but we will all suffer


The week has begun again with significant market turbulence as investors digest the reality that Russia’s invasion of Ukraine has had broad and far-reaching consequences for the world economy.  


Importantly for the rest of the world the major risk is that action against Russia escalates to such a point that its oil and gas supplies are switched off (by one or both parties). This would cause an oil shock that would likely lead to a recession in the Western world.  


It remains however an action that we believe is unlikely in a wholesale way. It is true that the United States may stop its own oil imports. However, at around 500,000 barrels a day this is just 5% of Russia’s daily output. The far bigger risk would be if Europe sought to shut off its own deliveries of either oil or gas. Russia produces around 40% of Europe’s energy needs and it is a shock that could not be borne without recession. In reality Russia produces 10% of the daily oil output and switching it off is not a realistic option.  


We think it is more likely therefore that there will be agreements reached to much fanfare to remove Russian energy dependence on a timeline of perhaps five years, which would clearly be more manageable.  Right now, the West has more to lose than Russia from taking dramatic action on energy. After all, for Russia they are already facing a deep and lasting recession as it turns itself into a sort of vast hermit state, like North Korea on a huge scale. Recession is probably the wrong word to describe it - Russia is facing a generational fall in living standards and a detachment from the technological and lifestyle gains enjoyed by people across the world in the past two decades. Putin has robbed their future. 

Putin may have signed up for this however we must remember that his state is ultimately a protection racket. Former KGB hoods act as gangsters who leave him in power in exchange for the right to asset strip the country and line their own enormous pockets. In a sense, it is the last great hurrah for fossil fuel extraction even as the climate crisis builds. 

The difference between him and Tony Soprano running a protection racket on the local grocery store is simply geography. At the end of it Tony and Vladimir have the money and the shops are empty.  

Putin’s actions have meant that the rest of the mob is now getting materially poorer. Their winter in St. Barts’ on a mega yacht has been replaced with winter in Moscow eating borscht and singing patriotic songs. They may well conclude this is not what they signed up for and yet act to remove Putin. Russian history is full of autocratic rulers who have complete control until one morning, quite to the surprise of the rest of us, they are gone in an instant.   However, whilst the worst for energy markets might well be avoided there is no doubt that the current environment will lead to continued volatility to portfolios. However, we believe that the actions we have taken so far in advance of this invasion place us well to weather it and emerge the other side in a good place to capture the ultimate stock market recovery. 


Let’s not forget that human psychology always tells us this crisis is worse than any other crisis and therefore maybe you should not simply ride it out but instead panic and sell. However, every crisis is different and ultimately the market has always recovered.  

In the meantime we believe our actions at the start of the year have helped portfolios in three distinct ways: 

  1. We removed allocations to emerging markets before the conflict started. This not only removed exposure to Russian equities, but also helped us avoid Eastern Europe where some of the worst share price declines have occurred. 

  2. We increased our exposure to US equities in a timely manner, allowing us to increase US dollar assets. US equities have outperformed since the crisis started and the dollar has rallied against sterling. This provides a cushion of protection for portfolios on days the US market is falling. 

  3. We increased our allocation to global infrastructure at the start of 2022. These funds have held up during the pullback and continue to provide portfolios with a highly stable stream of income and capital return.   

Within our portfolios the remaining significant active risk we are taking is largely within three funds. Our two UK picks that delve into small and mid-caps, TM Crux UK Special Situations and Chelverton UK Equity Growth and our European pick Marlborough European Special Situations. 


It is a good moment to pause and catch up with these fund managers. Below we include some comment from them this week:

TM Crux UK Special Situations fund manager Richard Penny:


“As you know we are a predominantly mid and small cap fund with a few large caps. We also have a bias to tech and health care. We received large inflows into the fund in the fourth quarter of 2021. We did not add to the tech holdings we owned, and weightings in the big contributors’ post the second quarter of 2020 are much reduced. We have lost some money on these technology and healthcare names, but it is much less than some competition and what people may have expected.  

“I see the sell-off in AIM and growth stocks as potentially very profitable for the way I invest. We did very well in the second quarter of 2020 but also in 1999, 2003 and 2008/9. Our oil weighting is 9.6% versus 10.2% for the index and we have no BP. Our commodities weighting is 9.2% vs 11.3% for the index. A bit underweight resources versus the All-Share but overweight versus small and mid-cap benchmarks and the exposure has been ok in the last week of Feb first week of March. We have cash of about 2%.” 

Our Verdict: UK small and mid-caps were hit hard when this volatility bit. However, relative to his peer group Penny has performed very well. We continue to believe we have to back experienced fund managers who can capitalise on these opportunities rather than simply hide in a crisis. Penny remains a favoured way for us to do this.


MI Chelverton UK Equity Growth fund manager James Baker:

“So far this year there has been quite a significant rotation out of growth into value. Against this backdrop we have started to add selectively to growth holdings where we think their shares are looking oversold. Overall, our aim is to come out of this period of volatility with a portfolio of our favourite growth names of high margin, cash generative, structural growth businesses with high levels of earnings visibility and the pricing power to withstand inflationary pressures, on a very attractive valuation. We think valuations can snap back from over-sold levels quite quickly and stocks trade on sensible (not on 2021 overvaluation levels) growth multiples, reflecting strong underlying growth supported by cash generation once the mood changes. Much as with the pandemic, any crisis with indiscriminate growth sell-off's presents opportunities we wouldn’t normally see, as the market overreacts enabling us to construct a very attractive portfolio for future outperformance.” 

Our Verdict: As inflation spiked all growth shares were aggressively sold-off and this has hurt the short-term relative performance of this fund. However, we are betting that the valuation discipline of Baker and his team will enable them to have an attractive portfolio for the recovery that is likely once growth expectations for the economy have begun to subside.

Marlborough European Special Situations fund manager David Walton:

“The fund itself has no holdings domiciled in Russia, Ukraine, or eastern Europe. We have estimated that the aggregated share of revenue of companies held by the fund in Russia and Ukraine was 1.2% in 2021.Our focus remains on well-managed companies which can generate substantial growth over the next 3-5 years. We are looking for opportunities to buy into such companies at cheap valuations during the current more difficult operating environment. At the same time, we are carefully scrutinizing holdings to be aware of any weakening of longer-term growth prospects. Our expectation is that higher cost inflation will be a drag on company profits for a period, but profit margins will be restored either through higher prices or a fall back in energy and commodity prices. Key point is to maintain a balance between defensive position and remain fully invested if and when equity market sentiment becomes more positive, which can happen very suddenly. The fund’s cash position going into this crisis was c10% of fund NAV and this is still the case today.” 

Our Verdict: We should not be naïve to the fact that this fund takes significant bets in European companies and whilst the exposure to Russia has been eliminated it will still be exposed to a growth shock on the continent. We have taken risk very selectively in our portfolios at the current time and choose to back Walton and his team to manage this situation carefully.


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