Russia No Longer a Viable Investment Destination
Given the geopolitical risks exacerbated by Russia’s invasion into Ukraine, we have sold Russia holdings and are evaluating other investments in the region.
Russia’s recent invasion of Ukraine sparked a flurry of Western sanctions and global condemnation of Vladimir Putin and his government. While the United States and its allies have moved quickly and dramatically to isolate Russia from the international financial system to force an end to this crisis, we don’t believe Russia will be a viable investment destination for the foreseeable future.
Russia’s cross-border moves represent a shift in the fundamental structure of Europe’s security regime, creating a new form of cold war between Russia and NATO. The potential implications of this shift have unnerved investors: The CBOE Market Volatility Index has risen above 30; investors have moved into havens, such as the U.S. dollar and U.S. Treasuries; and energy and commodity prices have spiked. While we believe Russia has several attractive businesses, in the wake of the invasion, we sold our remaining investments in the country, which against this geopolitical backdrop, we believe can no longer underpin sustainable above-average corporate earnings growth over our investment horizon.
The situation is changing rapidly, and we cannot predict what will happen over the days and weeks as sanctions increase, countries around the world send military support to Ukraine, and world leaders hold urgent meetings to try to end the fighting, which has already cost hundreds of lives and set in motion a refugee crisis. However, we know that in times of uncertainty, it is important to maintain focus on the long term and on finding the best growth businesses, benefiting from secular trends around the world.
Russia is No Longer Investable
Because of the geopolitical risks exacerbated by the invasion, we no longer view Russia as investable for Western-based, long-term investors. The uncertainties are too great and the situation too fluid. We don’t have the ability to predict what long-term impact the sanctions could have on Russia’s economy or its businesses. We are also unable to predict a political outcome, given the stronger-than-expected Ukrainian resistance and enormous international backlash against Russia.
We complement our deep fundamental business-focused research with a macroeconomic and political risk framework to assess the economic conditions and governance structure of individual countries as we consider investing in their businesses. In 2016, we determined that Russia had become an increasingly better fit with our framework. At that time, we saw improvements in macroeconomic conditions, supported by steady, if stagnant, economic growth, low debt levels, and a stable currency with a large current-account surplus buffer—assuming oil prices above $40 per barrel. That macroeconomic backdrop, combined with some pro-growth reforms and geopolitical stability as underpinned by the 2015 Minsk II agreement—which forged a ceasefire between Russia and Ukraine after Russia-backed separatists seized territory in eastern Ukraine—gave us the confidence to upgrade our classification of Russia to “stable” from “vulnerable.”
Although we upgraded the country, we have been vigilant with respect to the geopolitical risks since 2014 when Russia invaded and annexed Crimea. Cognizant of the risks, we have deliberately limited our exposure to Russia, allowing ownership of only two businesses and less than a five percent weight in our Emerging Markets Growth strategy. Additionally, we emphasized a higher level of business quality and selectivity, deliberately avoiding any sectors that we considered sensitive economically or exposed to the military, opting instead to concentrate on leading consumer-oriented technology and fintech businesses with no meaningful business-specific exposure to cross-border activities.
Late last year, we began debating Russia’s geopolitical stability as tensions escalated with Ukraine. We began reducing our positions in January as the developing conflict challenged our thesis on Russia’s macroeconomic stability and the ability of our portfolio businesses to add value over our investment time horizon of five years or more. As of February 25, we had completely sold the remaining shares of our Russian holdings, bringing our direct exposure to Russia and Ukraine to zero and our indirect exposure to less than one percent.
Impact on Risk Assets
While the situation remains opaque, we believe risk assets will continue to face pressure amid a flight to certainty and quality. Moreover, we expect inflation to accelerate, due to higher commodity prices and supply chain disruptions. Russia and Ukraine are key players in many raw materials markets, including oil, natural gas, palladium, and nickel.
Importantly, we believe many of the businesses we own should be largely immune from these structural inflation concerns. Many of our companies are driven by their intellectual property and build and sell digital goods at high incremental margins with low capital expenditure requirements. Most of these do not face cost inflation from energy, raw materials, supply chain pressure, or generic labor. We expect that the few that do face pressure will be able to use their pricing power and market share leadership to emerge even stronger from this challenge.
We are disappointed that we have been forced to sell businesses that we believe were world-class companies, providing value-adding services to consumers, backed by strong secular trends. But at this time, we believe that the macroeconomic concerns outweigh the fundamental strengths of these businesses. In the meantime, we have reallocated resources to higher-conviction portfolio businesses in areas that are not subject to the macroeconomic pressures created by the Ukrainian crisis.
We expect geopolitical and macroeconomic concerns to continue to drive stock price volatility as the crisis unfolds. To consider reentering select Russian businesses, we would need a credible, long-term security agreement that satisfied the interests of the Russian, Ukrainian, and leading Western governments. We see that as highly unlikely in the near-term, particularly under the current Russian regime.
Now more than ever, we need to emphasize that as active, long-term owners of businesses, we are primarily concerned with long-term growth trajectories for our businesses rather than short-term stock price movements. During periods of uncertainty, we believe our commitment to our six criteria will continue to help us uncover growth businesses with the potential to add value and enhance the wealth of our clients with prudence over time.
The views expressed are the opinion of Sands Capital and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of the date indicated and are subject to change. This material may contain forward-looking statements, which are subject to uncertainty and contingencies outside of Sands Capital’s control. Readers should not place undue reliance upon these forward-looking statements. There is no guarantee that Sands Capital will meet its stated goals. Past performance is not indicative of future results. All investments are subject to market risk, including the possible loss of principal. International investments can be riskier than US investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional and economic developments. Investments in emerging markets are subject to abrupt and severe price declines. The economic and political structures of developing nations, in most cases, do not compare favorably with the US or other developed countries in terms of wealth and stability, and their financial markets often lack liquidity. Because of this concentration in rapidly developing economies in a limited geographic area, the strategy involves a high degree of risk. In addition, the strategy is concentrated in a limited number of holdings. As a result, poor performance by a single large holding of the strategy would adversely affect its performance more than if the strategy were invested in a larger number of companies. The strategy’s growth investing style may become out of favor, which may result in periods of underperformance. You should not assume that any investment is or will be profitable. GIPS® reports and additional disclosures.
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