Is Your Portfolio (Unwittingly) Exposed To Russia?

Since Russia’s ill-advised and universally condemned attacks on and invasion of Ukraine on February 24, 2022, investments linked to the country have, in a word, tanked.

After countries of the west imposed harsh financial sanctions and cut the oligarch haven off from international banking, Russia’s domestic economy has been crippled, and its ongoing concerns abroad have been severely impaired.

The MOEX, known domestically as Московская биржа and internationally as the Moscow Exchange, has responded by suspending stock trading, which is ongoing at the time of this writing and the most prolonged pause since 1998. The Russian government intends to initiate a massive operation to buy up pummeled local stocks, unleashing $10 billion from its sovereign wealth fund for that purpose.

When trying to describe the current state of the Russian stock market, the word “bloodbath” comes to mind. Russian oil companies have seen losses as significant as 98%, suffered by Lukoil PJSC, with even the state-run Gazprom PJSC falling by over 90%. Its most prominent lending institution, Sberbank of Russia PJSC, saw depository receipts fall by 93% in London as of March 2, and there is currently no end in sight.

Why Russian Exposure Matters

This leaves investment managers in the U.S. in a tight spot. Funds that hold Russian securities may be unable to sell Russian shares, rendering them unable to meet the demand placed on them by exposure-wary investors minimizing their risk and pulling their money. Such a failure would force these funds to cannibalize their cash liquidity or even sell off other assets to compensate for such investor abandonment.

This poses a danger oddly reminiscent of the symbol of the long-deposed Russian monarchy: the double-headed eagle. These emerging-market fund managers face a two-headed threat in that the radical reduction of liquid assets forces an increase in their Russian holdings. Anyone with significant Russian exposure is likely to suffer financial frostbite as a result.

Insulating Factors

Thankfully, for most investors, all is not lost. While it is true that even everyday investors may have some exposure to these dizzying losses, it is likely quite limited and only a tiny part of their overall holdings.

American portfolios comprised of mutual funds or primarily exchange-traded funds may have many international holdings, but these are likely only a small part of a varied strategy that invests in emerging market funds.

Such funds invest in developing economies by purchasing stocks and bonds from Brazil, the Czech Republic, the UAE, and even Saudi Arabia. Before these latest developments, Turkey, China, and Peru were the bottom three emerging markets. Though official figures have yet to be tallied, it would be hard to believe that Russia, once one of the top emerging markets, hasn’t since supplanted one of the three.

The good news here for concerned investors is that their exposure is likely quite limited. Some of the most significant emerging markets funds hold as little as 2-3% stake in Russian stocks and bonds, which many analysts feel is not sufficient cause for alarm, and many such investors are likely prepared for at least the psychological impact of such risk, which is common to investment in developing economies.

Domestic Protection

Both Nasdaq and the NYSE halted trading in domestic depositary shares in several stocks with Russian lineage at the start of the trading week beginning February 28. These shares typically make up only a percentage of American Depositary Receipts.

ADRs, for the uninitiated, are bank-issued negotiable securities (listed in U.S. dollars) representing shares in any non-US company or interest and can be traded both on national exchanges and on the Over-The-Counter market.

Mutual funds and Exchange-Traded Funds invest in non-domestic stocks through ADRs, which function as a proxy for domestically traded stocks. ADRs give private and managed investors a legal and sanctioned “back door” to buy shares in foreign concerns such as Dutch-owned NXP Semiconductors, South Korea’s Amazon-like Coupang, Inc., and the Irish vehicle component manufacturer Aptiv Plc.

The halt in ADRs means all investors—including managed mutual funds and ETFs—are prohibited from trading these stocks. Upon the resumption of ADR trading, a period of adjustment for the returns of these funds occurs as the pre-halt figures no longer reflect current pricing for the previously frozen investments.

Global Scope, But Limited Scale

Funds that invest in foreign stocks are, as a rule, heavily diversified. Such portfolios likely hold a small share of Russia-tinged assets or debt, reflecting the Putin-led country’s global economic share. Though Russia’s economy was $1.65 trillion in 2021, this represents less than 2% of the global, $94 trillion world economy for that year.

A sufficiently diversified portfolio may, in turn, hold less than 25% of its stocks in non-US companies overall, and only 10% of those stocks are generally held in emerging markets. Russian interests are only a fraction of that figure, limiting investor risk to a fraction of their total investment.

Tolerable Risk?

It’s best to be cautious against a panicked selloff of Russia-focused investments, as whatever resolution comes in the current situation may favor stalwart investors who held their ground despite the bloodied and battered state of the Russian economy.

Emerging-market investment involves a volatile and often unpredictable relationship between risk and return, and informed investors are likely to realize this. Whatever your exposure may be, it is likely minimal and, considering possible post-war recovery; the uncertainty may be offset by rebounding returns.

Emerging-market investments have their place in portfolios — and investors who may have some Russian exposure in their assets are likely to be already aware of it. Savvy investors of this type likely have some form of protection in place. Risk-averse investors have likely avoided the volatility and uncertainty of these funds and are just as likely to be unaffected.

Stock Funds with Russian Exposure

A shortlist of stock funds that have more Russian exposure than most include:

• iShares MSCI Russia ETF
• VanEck Russia ETF
• GQG Partners Emerging Markets Equity R6
• GMO Resources III
• Invesco Emerging Markets All Cap A
• Kopernik Global All-Cap I
• Schwab Fundamental Emerging Markets Large Company Index ETF

A list of stocks with heavy exposure to Russia include:

• Philip Morris
• Pepsi
• Mohawk Industries
• McDonald’s
• EPAM Systems
• Carnival
• PVH Corp

If your portfolio has a heavy weighting towards any of these positions, it might be time to re-evaluate.