The Russia-Ukraine Debacle Tests Active Managers’ Prowess

Active managers in emerging markets were able to swiftly respond to the economic and investment fallout after Russia invaded Ukraine in late February and provide some level of protection from the crisis to investors. The geopolitical debacle tested active asset managers’ claims that that they win over their passive peers in less efficient emerging markets. 

Managers of active funds, unlike their passive peers, quickly sold their investments as trouble brewed in Eastern Europe. The average Russia exposure of actively managed emerging markets funds dropped dramatically from 3.19 percent in January to 0.8 percent in February when Russia invaded Ukraine, according to data that Morningstar pulled for Institutional Investor. The exposure declined further to a negligible 0.05 percent by March, with most funds reporting zero investments in Russia.

The dataset includes more than 200 actively managed open-end and exchange-traded funds domiciled in the U.S. in Morningstar’s diversified emerging markets category. About half the funds provided the research firm with March data.

The active managers that made the biggest moves in response to Russia’s invasion include Invesco Developing Markets, which reported over 7 percent exposure to Russian assets in January and only 0.26 percent by the following month. Baillie Gifford EM Equities III, which had over 6 percent invested in Russian stocks in January, dumped most of it by the end of February and reported that it had no investments in the country in March. Some funds even shed all of their double-digit Russia exposure in a matter of three months. 

Although investors in these active funds suffered losses, the pain was less than if they had been in index funds. Against a backdrop of heightened market volatility, the funds have lost an average of 12.5 percent since the day when Russian troops crossed the Ukrainian border, according to Morningstar. Meanwhile, the MSCI EM Index reported a negative return of 13.1 percent. MSCI did not drop Russia as a constituent in the index until early March. 

The ability to sell investments quickly was critical. Many strategists argue it was difficult, if not impossible, to predict the war, let alone the fallout. Marko Papic, chief strategist at Clocktower Group and a geopolitical expert, said the unfolding of the Ukraine war surprised even the Chinese government, one of Russia’s closest allies.

Unlike passive funds that invest in accordance with benchmarks, active managers have the flexibility to pull out of their investments in certain countries, according to Mike Hunstad, head of quantitative strategies at Northern Trust Asset Management. Of course, that flexibility was limited after the West hit Russia with sanctions and many investments in the country were frozen. 

“It was very unclear how the war was going to progress or how the markets were going to react, so it was very, very difficult to make [investment] decisions,” Hunstad said.

There were plenty of active managers that did not act quickly enough to protect investors. In a March blog post, Harding Loevner’s vice chairman Simon Hallett admitted that the 8 percent Russia exposure in the firm’s emerging market strategy had led the portfolio to “suffer” and that the carrying value of all its Russian holdings had been completely wiped out. According to Morningstar, the strategy has lost 19.5 percent since the invasion began.

But Hallett was unapologetic about the firm’s investment strategy. “Hindsight makes for extremely accurate forecasts,” he wrote. “From a portfolio diversification perspective, we held the [Russian] investments in part as an inflation hedge through the exposure to energy that two of the companies provided, and in part as an antidote to our concerns about the valuation risk we saw building in many other parts of the global equity market — knowing full well that the antidote came with geopolitical risk.”