As a world event, the Ukraine War is seismic, and has edged out most topics from the financial news cycle since February. The human horror and loss is evident and growing daily. It is also having a wide impact on global politics and finance. Given its role in financial markets, it is worth seeing what has the impact of the war been on the €130 billion or so in Irish Pension Funds and what should pension investors do.
2022 didn’t get off to a great start for Irish pension funds anyway. Fears over run-away inflation and higher interest rates at the start of the year knocked market returns. The average Irish Pension Fund lost about 3% in January. February wasn’t much better and we saw the dip continue driven by the same reasons – surging cost of living, central banks rushing to catch up, and then – the early stages of the war. The average Irish Pension Fund was down about 2% in February.
Market response to the outbreak of war in Ukraine has been complex. Immediately on the invasion, global markets fell away until they found a level in early March. From that low, by the end of the month, world equites were up nearly 10%! As the war moved into a more static phase, global shares become less responsive. This is visible in stock market volatility, which, as measured by the VIX index, peaked on March 7th and has been broadly declining since then. So since early March, we have on-going conflict coupled with positive financial markets.
This market response has resulted in a much better March for Irish Pension funds. A standard managed fund returned between positive 2 and 3% – much better than either January or February.
In the worst of the war, pension funds have moved ahead.
In fact looking at this first quarter, factors such as global interest rates have been much more dynamic and influential for pension fund investors than events in Ukraine. In the US, 10 year yields started the year at 1.4%, but are now close to 2.8%. German 10 year bunds went from negative 0.2% to close to 0.8% today. These are significant moves and in fact improved the health of many defined benefit pension schemes in reducing the value of future liabilities. These moves in government bond markets point to the interest rate debate being a critical one for investors.
Initial strategy calls from large global investment houses were very much to hold positions. Some advised to “take some risk off the table” while essentially meant reducing equity holdings but staying overweight.
Several commentators looked to what stock markets had done in recent outbreaks of conflict such as the Gulf Wars, Iraq, Vietnam. In these instances markets regained their poise in relatively short order. But in certain respects many of these events were quite contained.
There is little that is contained about the Ukraine conflict.
It’s clear that stock markets haven’t been following every ebb and flow of events in Ukraine – especially after the initial ‘shock and awe’ of the invasion. On occasion, markets have responded on days of dramatic news, such as constructive talks – often to lose it again. Rather than the direct progress of the war, it is the secondary effects of increased energy costs, possible food shortages, supply chain disruption, job losses where markets have rightly been focussed.
There may well be a long way to go in this conflict. The risk of corporate defaults and the inability to sell Russian assets may increase the direct systemic impact from the war. Many corporates are closing Russian operations. Several funds investing in Russia have been forced to suspend dealing. Some UK pension funds are divesting of Russian assets. Russia has been removed from many market indices but we have yet to see any material impact on the world’s financial plumbing.
Even if events take a positive turn, we are unlikely to see a swift removal of sanctions or restoration of supply chains. Investors should adopt an equally careful approach and not react to events.
Markets find it very hard to price geo-political risk. Prepare rather than predict by ensuring diversification and eliminating disproportionate exposure to at risk sectors and stocks. But attempting market timing in a potentially volatile landscape is a risky strategy.
But it may well be that looking back on 2022, it will be the usual suspects of interest rates, inflation, oil prices and a deteriorating company earnings outlook that were the real market drivers.
Tradewinds 