Brian Jacobsen visited with several of our portfolio managers to hear their views not only on Ukraine but also what crises like it can show about the need for broader risk management in volatile areas such as the emerging markets. In the first of our series, Brian spoke with Dale Winner, CFA, co-portfolio manager at Everkey Global Equity, about Ukraine and what investors can learn about investing in emerging markets from the crisis there. The views expressed about the quickly changing developments in Ukraine are as of March 4, but Dale also speaks about strategic ways to approach emerging markets investing in general.
What concerns you most about events in Ukraine?
What really concerns us most is if Russia’s military action escalates, because that will obviously result in pretty severe economic sanctions against Russia, which would continue the pressure on the ruble and also on the economic growth rate of Russia. Another risk in that scenario, given that a lot of gas supplies to Europe go through Ukraine from Russia, would be that any disruption to those supplies could result in spiking oil prices. That would be our worst-case scenario. Our base-case scenario is actually a de-escalation of the military action to start with, and we did see evidence of that on Tuesday, followed by legitimate elections in Ukraine, as well as a very important refinancing package for Ukraine to refinance their large debt load, which would probably come from a mix of the IMF [International Monetary Fund], Russia, Europe, and also the U.S. That would be our base-case scenario.
What is your risk management strategy for events like these?
We incorporate risk into our investment process from the very beginning, when we’re looking at the upside versus downside of stocks. For emerging markets stocks such as Russia’s, which I’ve been constantly following for more than 20 years, we obviously had to have a bigger risk discount to account for the volatility of those stocks. However, for us, it’s all about valuation. What is priced into the stock? And that’s where Russia becomes very interesting, particularly after the sell-off. Simply put, although emerging markets as a class is probably trading around 9 to 10 times earnings, the Russia index is trading at 4 to 5 times earnings. That’s a remarkable discount. We think that a lot of risk management can be put in terms of the upside versus downside. That being said, as emerging markets stock investors, we also have to have a top-down macro view. Regarding Russia, since the May rout of last year when the first signs of tapering came through and caused volatility in certain emerging markets, we definitely had a macro view on emerging markets, trying to put a line between countries with structurally weak current accounts, such as Brazil, South Africa, Turkey, and those that have budget surpluses and/or strong current accounts. And, those would include, for example, China, South Korea, and even Russia. So, we have had a macro view top down on Russia, which actually has been relatively positive. At the end of the line, it’s all about valuation, and we think the valuations are over-discounting that macro risk.