Russia-Ukraine tensions and Russian equities

Since 11 November 2021, when the major headlines regarding the escalation of geopolitical tensions appeared, the Russian equity market has underperformed the broader emerging markets (EM) index by about 9% in USD terms. In our estimation, of that underperformance, about 7% was due to the Russia-specific factors related to geopolitical risks.

Graph 1. Decomposition of Russian equity market vs EM index excess return by Russia-specific and sectors factors

Note: To calculate the country-specific effect, we constructed an index from the EM sector indices with the structure of the MSCI Russia 10/40 index. For example, we took the MSCI EM Energy index and weighted it at 38%, the MSCI EM Materials index at 27%, etc. Therefore, the excess return due to Russia-specific factors equals the MSCI Russia 10/40 minus the constructed index. Based on net return figures, in USD terms.
Source: Bloomberg, TKB Investment Partners; Data as at 23 November 2021

Is there any material downside left? We believe its unlikely that any further underperformance due to the Russia-specific factors would exceed 800bp. Looking at the historical evidence, even in more politically sensitive cases like the Crimea annexation, in 80% of situations, the underperformance due to the Russia-specific effect did not exceed 15%. Moreover, there was always a complete rebound from such events, in most cases in fewer than 90 days (see Graph 2).

Graph 2. Cumulative Russia-specific effect on excess return of Russian equity market vs EM index after sanction risk-related events (range of negative cumulative effects after a particular sanction-related topic started to develop)

* The cumulative negative effect was below minus 15% only in the end of 2014 – beginning of 2015 when a chain of events related to annexation of Crimea effected the market coupled with the strong drop of oil prices. The cumulative country-specific effect is demonstrated from the day before the sanctions risk-related event until the effect evaporates. Based on net return figures, in USD terms.
Source: Bloomberg, TKB Investment Partners; Data as at 23 November 2021

The risk of military escalation is low, in our view. Over the last eight years, Russia troops have never been seen in advance actually entering a particular territory. The current events appear to be more of a ‘power move’ on Russia’s part, designed to intimidate and to devaluate the reputation of the foreign intelligence agencies.

At the moment, US intelligence reports about 90 000+ Russian soldiers along the Ukraine border. This is similar to April 2021, when Western and Ukraine intelligence agencies predicted that Russian troops would enter Ukraine territory. They claimed that Russia massed about 80 000 soldiers along the border. We believe that the current situation, as in April, poses no material military threat.

In our view, Russia may continue flexing its military muscle to provoke further headlines. That way, following multiple false alarms, people will likely stop reacting as emotionally to such military moves.

The potential for the Russian market to outperform EM has improved. We believe financial markets have overreacted to the Ukraine headlines, despite fundamentally there having been no change in the situation, in our view. We believe the reason for such an emotional reaction was that these perceived geopolitical risks arose on top of investor concerns over rising global inflation and recession fears.

The risk of material sanctions remains low, in our view.

  • At least until the Nord Stream-2 gas pipeline is fully certified and launched, it is likely that Russia will be cautious about its external politics so as not to harm its relationship with the EU. Moreover, Russia could use the situation with Belarus as a bargaining chip to gain some benefits from its relationship with the EU
  • Any material sanctions are likely to have a dramatic boomerang effect due to the deep integration of the Russian economy within the global economy. Russia is the world’s second largest net exporter of crude oil and has a 60% share of overall gas exports to Europe. It is one of the top 20 countries in terms of international trade volumes.


Authors: Vladimir Tsuprov, CIO, Egor Kiselev, Head of International Business & Investment Marketing, Aleksandra Kuznetsova, Investment Specialist, Marina Tsutskiridze, Investment Specialist

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