Ukraine conflict: five ways to reposition your portfolio

The financial implications of Russia’s invasion of Ukraine pale into insignificance compared with the human suffering it is causing, but professional investors still have a fiduciary duty to maximise their clients’ returns and reposition their portfolios. In this article we share some ideas about the actions you could take in these turbulent times.

Uncertainty upon uncertainty

Investors were already faced with some big unknowns as the world moved out of the pandemic, not least whether high inflation was likely to last and how central banks might react. But now, Russia’s invasion of Ukraine has piled uncertainty upon uncertainty. As well as opening-up a troubling new set of issues, it’s made the potential impact of existing problems harder to read. Energy prices are set to rise even higher, providing further fuel to the inflation fire, but will the effects on people’s disposable incomes offset or even outweigh this? And what does all this mean for central banks – will they hike rates as planned, or will they now adopt a more cautious stance?

We’re still assessing the implications for investors as events unfold. In particular, we’re watching the central banks’ reactions closely and are mindful that heightened geopolitical uncertainty will affect the performance of risk assets in the near term.

On this basis, many investors are going to want to adjust their portfolios’ risk exposure in the short term. Below we set out five things you could do:

1. Protect against inflation without duration risk

Energy and commodity prices have hit new highs for the current economic cycle since the invasion. The knock-on effects of the conflict – from sanctions to trade disruptions – have created further uncertainty, both for the inflation outlook and central bank policy.

Our view is that real rates are likely to stray further into negative territory and inflation breakevens – the difference between the nominal yield of a standard bond and the real yield of an inflation-linked investment of similar maturity and credit quality – will increase further. With this in mind, we believe inflation expectations strategies should continue to perform well.

2. Reduce rate sensitivity with short-term bonds

Rampant inflation has piled pressure on central banks like the Fed to tighten more aggressively. That’s typically bad news for bonds. But at the same time, the invasion is likely to boost demand for safe-haven investments – including government bonds.

Tackling these conflicting drivers may best be done by allocating to government bonds with very short duration. Bonds like these are much less exposed to interest rate risk than their longer-dated counterparts, and the positive carry and rolldown they provide means they have scope to outperform cash.

3. Switch towards defensive sectors

After a sharp rebound last year, the euro area’s growth outlook is suddenly much less certain. Supply disruptions and skyrocketing energy prices are denting growth potential, while high input costs are bad news for businesses with low margins, high levels of debt and limited growth opportunities. What’s more, the economic sanctions imposed in the aftermath of the invasion could raise the spectre of stagflation, leading investors to rotate into more defensive sectors.

In this kind of environment, we believe sectors with high margins and low debt are best placed to outperform - Healthcare is a great example.

5. Shield from volatility with gold

Gold recently surpassed $2,000/oz for the first time since the height of the pandemic, before rolling back closer to $1,900/oz. Given its safe-haven status, investors are likely to carry on buying it as long as they’re worried about the value of other assets.

So, the prevailing geopolitical uncertainty could help gold rise further in the near term. And, the low correlation of gold’s returns with those of other assets means an allocation may help reduce a broad portfolio’s volatility, enhancing its risk-adjusted return potential.