Dear Partners, dear Investors,
The global economy saw 2021 end with a spectacular momentum (strong growth in the fourth quarter across all countries of the world, historically intense and synchronised). This momentum has continued into January-February 2022 thanks to the following factors:
- Full employment & above potential growth ;
- Strong household spending due to increased savings during Covid;
- Inflation shifting from transitory to cyclical;
- Change in central banks’ rhetoric admitting this scenario.
The consequence was the beginning of a long-term cycle of outperformance for cyclical and value securities across all asset classes, as well as a pronounced sell-off in G4 bonds (US, Germany, UK, Japan). This cycle was very favourable for our portfolio positioning at the beginning of the year and we maintain our long-term view on this major rotation.
Despite the violence and intensity of the conflict in Ukraine, neither the war nor the sanctions on Russia constitute a systemic risk for financial markets. This means that the reaction of the latter is similar to what we experienced during Brexit. The Covid crisis or the collapse of Lehman Brothers, on the other hand, triggered global crises with longer and deeper consequences for the markets.
During a localised crisis, the shock is symmetrical in nature with the following consequences:
On the one hand, a sharp fall in assets which stand directly affected by the crisis (exit from global indices, increase in volatility, investment committee decisions, global redemption flows to be adjusted).
On the other hand, a fall in other risky assets, peripheral to the crisis, within a limited contagion effect.
Assets affected by the contagion mechanically return to normal levels through the arrival of new opportunistic and unconstrained investors. For assets directly impacted by the crisis, normalisation may take longer if their fundamentals have deteriorated. For Russian assets, it would be very premature at this stage to talk about a deterioration of fundamentals. They should therefore continue to normalise.
Management of Russian Assets:
Given the depreciation of Russian assets up to March 7th, stressing the mechanical part of the movement, our exposure to the ruble fell, notably due to the price drop on local debt and adjustments made to some of our portfolios. We have therefore recently decided to rebalance our exposure to Russian assets through the acquisition of local debt at deep discounts (valued between 3% and 8% of par), which represents a form of optionality.
At present, sanctions continue to affect the free price discovery of Russian assets in the offshore markets to which international investors have access. However, the liquidity of such assets is improving in international markets as these same assets are trading at much higher prices on the « onshore » marketplace where local investors trade.
These more favourable price levels observed in the local market are justified by the fact that:
Russia has already reopened its equity market for local investors;
The country pays coupons in ruble locally and in US dollar on its foreign debt;
Fundamentals remain generally good: an extremely low debt-to-GDP ratio (around 15%) and very high revenues due to rising oil and gas prices. Thus, no solvency problems are expected, even in an extremely adverse scenario;
The Russian central bank has reopened the local sovereign debt market to local investors and has expressed its intention to buy bonds in order to benefit from low prices and improve its debt profile;
Russia has a strong incentive to service future coupons as Russian banks would have to pay large sums to foreign banks in case of default (triggering Credit Default Swaps).
Please find below the latest communication from H2O AM:
2022.03.31_H2O-AM_The-war-in-Ukraine-a-non-systemic-crisis-for-the-markets