Investors have shifted their anxiety from the economic impact of Russia’s invasion of Ukraine to larger macroeconomic issues that are now looming over the markets.
In his most recent letter to investors, Kevin Russell, the chief investment officer of alternatives firm UBS O’Connor, wrote that while institutional investors are less concerned with the war this month, anxiety around the “economic conundrum” of ongoing inflation pressures, tightening monetary policy, and the risk of a recession are now top of mind.
In March, Bank of America’s Global Fund Manager Survey found that about half of 200 global institutions, hedge fund managers and other investors believed the Russia-Ukraine war was the biggest tail risk facing their portfolios. By April, Russell stressed that BofA’s flagship survey found that dropped to only 16 percent of respondents.
However, investors’ concerns about the potential for a global recession, hawkish central banks, and inflation increased significantly from last month.
“Those risks are going up and the geopolitical military conflict risk is going down,” Russell told Institutional Investor.
Russell said the new fears have translated into high-velocity moves in interest rates, which have in turn caused dislocation in factors like growth and significant underperformance.
Investors can be forgiven for not understanding the complexity in the current environment, said Russell. After all, a generation of investors hasn’t had to think about inflation’s effect on asset prices, he said. (O’Connor is agnostic to macro risks: it doesn’t try to predict or position for them as much as determine where the risks are discounted so it can make capital allocation decisions.)
There are new opportunities as well. “In credit spreads in the corporate market, we think that the worst of that volatility is behind us,” Russell said. “[Now] we’re getting more active in our portfolios, focusing a bit more on growth sectors and getting a bit more active buying bonds — both investment grade and in the high-yield market.”
UBS O’Connor also sees potential opportunities in capital structure-focused strategies as investors adjust to the new realities facing companies and in merger arbitrage.
Still, investors are pessimistic about economic growth. BofA’s survey found that those who expect a strong economy is at an all-time low. Russell said, unsurprisingly, this pessimism is caused in part by inflation and higher interest rates. But the CIO is surprised that the “feedback loop” is causing the contraction in economic output to be as high as it’s ever been.
The CIO counseled clients to take a longer-term outlook overall.
“I think people are just caught up on what the Fed is saying right now,” he said. It’s difficult for investors to make sense of the Fed’s seemingly paradoxical stance that there is both high-grade inflation and a risk of a recession.
“Those are statements that don’t normally go together, and it’s hard for investors to reconcile them,” he added.