Lessons for Investors From Post-Invasion Markets

Smart diversification, inflation protection come to the fore.

Sandy Ward 15 March, 2022 | 2:59AM
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Ukraine Train

The Russian invasion of Ukraine sent shockwaves throughout global financial markets as countries moved quickly to impose harsh economic sanctions on Russia.

Stock markets have zigzagged wildly as investors struggled to make sense of the latest developments and assess the ripples from the rapidly changing geopolitical landscape.

Investors have been left scrambling to asses their exposure to Russian stocks or bonds. Meanwhile, prices of critical commodities--crude oil, natural gas, wheat, nickel, and palladium--skyrocketed, in some cases to unprecedented levels, on expected disruptions in supplies. Expectations for looming Federal Reserve interest-rate increases were rapidly scaled back even as soaring energy prices worsened the inflation outlook. Some in the markets even began talking about a recession. 

For investors, the volatility serves as a jarring reminder to maintain diverse portfolios, keep a long-term outlook, adopt a disciplined rebalancing approach, and stay invested. 

What Good Diversification Looks Like

It's likely been a particularly tough lesson for those who turned to investing while under pandemic restrictions, becoming stay-at-home day traders, often loading up on so-called meme stocks and chasing the latest hot trend or sector. 

"It's very hard to position portfolios around unknown geopolitical events," says Jim Masturzo, partner and chief investment officer of multi-asset strategies at Newport Beach, California-based Research Affiliates. "And thinking about shockproofing portfolios once the tanks roll is too late. It all goes back to the fundamental idea of having a diversified portfolio."

Ricky Williamson, portfolio manager and head of U.S. outcome-based strategies for Morningstar Investment Management, cautions against a "kitchen-sink" approach to diversification and advises folks to be "intentional," focusing on high-conviction ideas and thinking through the risks associated with them and identifying ways to offset the risk. Whatever you do, "stay invested, seek opportunities globally, and don't try and build a portfolio based on geopolitical considerations," he says.  

Meb Faber, founder and chief executive of Cambria Investment Management, a quantitative and alternatives fund manager based in El Segundo, California, advises individuals to "have a guide, a plan, otherwise you're always grappling with the uncertainties of the world." His current models are forecasting "zero real returns on U.S. stocks in the next decade," but he maintains that "value is a great place to hide, and foreign stocks are also a great place to be." 

How to Protect Against Inflation

Three weeks ago, inflation and the size and number of well-telegraphed imminent interest-rate hikes expected from the Fed amounted to the biggest concerns facing investors.

Investors have scaled back expectations around the pace of Fed rate increases to a quarter-point boost to the federal-funds rate instead of a half-point increase. But thanks to the surge in oil and commodity prices, inflation expectations are once again on the rise.

The challenge for the markets and investors remains inflation, says Masturzo. "Inflation is still the backdrop behind everything," he says. "As tragic as the war in Ukraine is, what the Federal Reserve is going to do, and the Bank of Japan and the Bank of England, and the European Central Bank, all central banks, will be more impactful."  

To hedge against inflation, he says, investors should consider TIPS, or Treasury Inflation-Protected Securities, bonds that are designed to rise in value as consumer prices increase, and real estate, including REITs, or real estate development trusts, and commercial real estate, because real estate values tend to rise with inflation and provide a built-in hedge. (However, TIPS are complicated investments, and don't always perform the way investors expect them to.)

While investors might be tempted to boost exposure to commodities or precious metals, Masturzo reminds investors to be clear-eyed about the role they might serve in the portfolio. He cautions that long-term returns in those asset classes, net inflation, are minuscule if they even amount to more than zero. Weather, for instance, plays a huge role in the performance of agricultural commodities, and we all know how difficult it is to predict the weather. Still, if you must have a position, Masturzo advises using actively managed funds in which managers hold commodity-related companies and/or futures contracts on the underlying commodity.

Morningstar's Williamson also eschews commodities and precious metals. "We're not going to have exposure to assets without meaningful cash flows," he says. 

His current portfolios have a bias toward non-U.S. equities, U.S. and non-U.S. cyclical stocks, and the energy and financials sectors. 

Credit-sensitive equities and defensive fixed-income securities such as TIPS and long-term Treasuries can provide a shield against economic shocks, says Williamson. In a low-growth, high-inflation environment, known as "stagflation," real estate will provide protection.

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Sandy Ward  Sandy Ward is a markets columnist for Morningstar.com

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