Beyond Bulls & Bears

Equity

Geopolitical Risks in the United Kingdom

As geopolitical tensions escalate across the globe, our UK Equity team provides its insights into Russia’s invasion of Ukraine and the implications for UK-listed companies.

This post is also available in: German

by Martin Currie UK Equity Team

 

What is Happening in Ukraine?

Tensions have been high between Russia and Ukraine since long before the 2014 annexation of Crimea, underpinning a tumultuous history between the two regions. Accusations of an improving alliance between Ukraine and the Western world have exacerbated these tensions. These hostilities have considerably escalated in recent months, intensified by the amassment of Russian troops along the Eastern Ukrainian border. February’s invasion of Ukraine has sparked global outrage and protest, triggering a barrage of sanctions applied to Russian businesses and individuals, most notably their expulsion from global banking system SWIFT.

As international/Russian economic relations sever whilst the conflict deepens, the Russian central bank has been forced to respond in an attempt to combat the impact of Western sanctions. The Russian ruble had slumped 30% against the US dollar before the central bank doubled interest rates to 20% and committed to unprecedented monetary support to maintain financial stability. With thousands of displaced refugees in Ukraine, and Russian citizens flooding to dispense cash from foreign currency ATMs, the state of affairs across the two nations can be described as nothing less than a crisis on both a humanitarian and an economic level.

What Does This Mean for the United Kingdom?

As long-only UK investors, we have no direct exposure to Russian companies; however, due to the composition of the UK market, there are some sectors which the ongoing conflict may disproportionately impact. Naturally, the main exposures are concentrated within large-cap equities, where 70% of the earnings of FTSE 100 Index companies are generated overseas; however, we are seeing at least some impact across the capitalisation spectrum.

In our small- and mid-cap portfolios, we try to avoid companies whose profits are significantly correlated with commodity volatility. This allows us to focus on alternative structural growth areas where we believe that risk/return profiles are more attractive. Consequently, we have no direct exposure to any oil, gas or mining companies within our small- and mid-cap portfolios. Oil and gas accounts for around 9% of the FTSE All Share index, and when we consider this alongside Russia as one of the largest exporters of oil in the world, the interrelationship becomes evident. As concern grows over the supply of oil from Russia to the Western world, the price per barrel has soared to as high as US$105, which provides a tailwind for the UK-listed oil giants. We have closely monitored BP’s decision to dispose of its 19.75% stake in Russian state-owned oil firm Rosneft, and sanctions aside, we would suggest that divestment has been a long-time consideration as BP repositions itself as a green energy leader.

We have also seen some shifts in the aerospace and defence sector as Russia’s invasion of Ukraine has prompted a review of European defence budgets. Thus far, Germany has vowed to invest €100 billion in its military this year in a response to a new era of Russian hostility, and investors are expecting other global powers to follow suit.

Conversely, Russia is a large supplier of titanium into the Western aerospace and defence industry, and this could potentially create some major supply chain issues should Russia retaliate to sanctions applied by the Western world. Within the UK-listed miners, we are seeing supply chain constraints feeding through to commodity prices. As doubt is cast over the future supply of commodities, the consequent price spike provides a tailwind for mining stocks. As with most commodity price increases, we must consider the flip side of the coin and who ultimately bears the brunt of the spike.

Higher commodity prices are likely to cause cost pressures on a number of industries, and we must be mindful that this could also feed through to consumer spending. We have already seen this year the extent to which rising energy and food prices can squeeze household budgets. As uncertainty clouds future supply chains, the pressures for companies operating in Europe are likely to have a knock-on effect across the value chain. This compromises the policy outlook for central banks, which are faced with a dilemma on whether to increase interest rates to combat inflation in the midst of such a geopolitical crisis, thus heightening the risk of an incorrect policy call. Consequently, forecasting to any degree of accuracy remains testing, so we believe that retaining our long-term discipline in quality companies trading on reasonable valuations will support our navigation through periods of volatility.

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Smaller and newer companies can be particularly sensitive to changing economic conditions. Their growth prospects are less certain than those of larger, more established companies, and they can be volatile. Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

Get Content Alerts in My Inbox

Receive email alerts when a new blog is posted.