Be ready for a Russian default as sanctions bite

Be wary about holding growth assets right now — and consider some rotation to bonds says Pendal’s OLIVER GE

RUSSIA’S unprovoked invasion of Ukraine continues to attract sanctions aimed at limiting the terrible human toll in that part of the world.

The financial implications of those sanctions are of course reverberating far and wide in markets around the globe — and few investors would argue against such action.

But what does it mean in terms of asset allocation? Especially if the sanctions cause Russia to default?

“There is an increasing chance that Russia might default and that has implications for Europe,” says Oliver Ge, a portfolio analyst with Pendal’s Income and Fixed Interest team.

“That in turn hurts the United States and the rest of the global economy.”

“The average investor might take a cursory glance at what’s happening in Ukraine, but I’d argue it’s going to have major ramifications.”

“Russia has about $US640 billion of reserves of which $US400 billion is frozen in central banks around the world. On conservative estimates, it costs about $US1 billion a day to run the war so the impact to Russian coffers is material.”

“Even though energy products haven’t been sanctioned, many global buyers are staying away from Russian energy. If the war is protracted and the sanctions remain in place, pressure on the Russian economy will build.”

“It is also going to be a very challenging environment for neighbouring countries in Europe — not only through the energy channel and its effect on business margins but also through second-order effects via the banking sector in the form of bad debts.

“This will take time to fully play out but we are already seeing the cracks form.”

Financial impact in Australia

“At the start of the year, the consensus forecast for Aussie equities was for growth of about 5 per cent. Not a huge amount but a nice little bump. And that’s driven by the fact that we are in recovery mode.

“That hasn’t happened, predominantly because of Russia’s invasion of Ukraine. It doesn’t matter how much direct exposure our big companies have to Russia — once markets become concerned the effects spread around the world.

“The message to advisers is that if you were told at the start of the year that you’d get 5 to 7 per cent growth, that’s not going to play out in the current state of affairs.”

“So, you should be very wary about holding growth assets and potentially think about some rotation to bonds. Bonds will keep paying,” he says.

“It shouldn’t be a massive rotation, but investors should be more mindful around the expectations of growth assets.”

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Pendal’s Income and Fixed Interest funds

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About Oliver Ge and Pendal’s Income and Fixed Interest team

Oliver is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s fixed interest strategies here

About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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