The Conflict in Ukraine and Its Impact on Markets

Well, welcome to the Dimensional Investing Broadcast. I'm Courtney Scott. And I'm Jake DeKinder. And we wanted to spend a few minutes this morning discussing the conflict in Ukraine and the impact on markets. Certainly a tough situation in Ukraine, Court. Yeah and certainly our thoughts go out to everybody affected with the conflict in Ukraine. Yeah, that's exactly right. We know that many of the employees here at Dimensional, many of our clients, people all around the world are thinking about what's going on. May have family, may have friends there. So, again, as you mentioned, thoughts go out to all of those people affected by the conflict. Yeah, absolutely. And we certainly have been getting a lot of questions from clients around this particular topic. Yeah, that's exactly right. We've had questions come in from clients of Dimensional, just wanting to know how Dimensional is handling the situation, what we're seeing in markets around the world. So, thought it might be good to spend a little bit of time speaking with our global investment team. That's right and we have a 24-6 process at Dimensional with our portfolio managers and traders that seamlessly hand out that process throughout the trading day across the globe. And so, earlier we were asking questions to Bhanu Singh, Head of Portfolio Management in our APAC region. And we were asking questions around how to access the Russian market and some of our exposure in our portfolios at that particular area. So, let's go ahead and hear from Bhanu in our Sydney office. Good morning everyone and thank you for the question. Look, when it comes to Russia, it's a market we know fairly well. We've been investing in it since 2009. And one of the things we do when we add a new country to our portfolios is we do a pretty thorough due diligence process around it. We look at things like the size and liquidity of the market. We look at listing standards for the local exchanges. We look at settlement mechanisms, we look property rights, particularly for foreign investors. And when we were looking at Russia, one of the things that stood out was that the listing standards on exchanges were somewhat lax. So, what we ended up doing was that instead of buying local Russian securities in rubles, we decided to get our exposure through what are called depository receipts. So, from the very beginning, we've been getting our exposure through securities listed in places like London and America. What that means is they have to meet the same listing standards as any other security listed in US and UK, which we think those standards are a lot better than the ones in Russia. So, that means that in times like these, we don't have to buy rubles to transact in local Russian securities, we're dealing in pounds and dollars, which makes life a lot easier. Now, this practice of using depository receipts is fairly common in emerging markets, it's not unique to Russia. For example, a bunch of companies in India that use ADRs for the same reasons. So, overall fairly standard practice. Now, taking a step back and looking at Russia, our weight in Russian securities is fairly small, right? So, when it comes to Russia, we invest in it through our emerging market strategies and the typical weight to Russia in our strategies is fairly small, around 1 to 1 1/2%. So, that means just right there, that means that our day to day portfolio management processes are not going to be impacted by any trouble in a very small market like Russia. So, that's the first step. Now, our weight in Russia is actually quite lower than a typical benchmark weight, which is around 3 to 4%. And that's also a very deliberate decision on our part. In 2014, we were quite concerned about the treatment of foreign investors in Russia and due to that, the investment committee at the time decided to reduce our holdings in Russia and to have a systematic underweight to Russia. So, since then, we've had a lower weight in Russian securities than the market or benchmark, which would've helped the portfolio in the recent volatility. But overall, the exposure is pretty small. Now, Russia is a fairly concentrated market, far more in 2009 than today. In 2009, Gazprom which is large oil company, made up 45% of the Russian market, 43% if I'm remembering correctly but today it's around 15, 16%. So, the Russian market is concentrated but nothing unique in the emerging markets. So, pretty standard in terms of our day-to-day implementation processes. And we feel pretty comfortable applying our systematic process in Russia. So, hopefully that gives you a bit more context around the exposure to Russia and our portfolios and how we are dealing with it on a day-to-day PM perspective. Now, looking forward, we're currently evaluating some of the sanctions that have been issued by UK, US and Eurozone. And that may have some changes on our holding in Russian securities but I'd like to just remind everyone that it's such a small weight in the portfolio that at any holdings are likely to be very immaterial to the overall portfolio. So, hopefully that gives you a bit more info, back to you guys. You know, Jake, it's always helpful to understand how we access markets and also the overall weight within the portfolios and great to hear from Bhanu in our Sydney office. Yeah, definitely. Great to get the update there from Bhanu. Let's go ahead and let's move over to Europe, to London and actually hear from Mark Butterworth, who is Head of Equity Trading over in EMIA. Mark, it's good to have you on the broadcast this morning. We heard from Bhanu there out of APAC, let's get some perspective from you on what we're seeing in the European markets, looking at liquidity, looking at spreads over the last couple of days. Sure, morning, Jake. Yes, yesterday before the European markets opened, we were checking in with our APAC team to understand what happened in those markets overnight. So, when our markets opened down 3 to 5%, it was as we expected. Like I said, across the board, market is down between 3 and 5%. Those markets more heavily exposed to Russia, that being Italy, Germany and France were down more. Over the course of the morning, there was a small rally in markets but pretty much, they stayed down in that range over the rest of the day. Volumes were up considerably, not massive, not greater than say a flash crash or Brexit or anything like that but considerably higher than normal. Spreads were wider and the value available to the touch, so if you are an urgent buyer or a seller and you have to cross that spread, not only is it wider but the value available to you there is decreased. That was down, say 20% yesterday. Markets today, have recovered slightly. We've seen them up 3% across the board. And they're holding at those levels over the whole of the day so far. We saw that Russian, GDR specifically, got hit really hard yesterday, as you would expect, those were down between 30 and 50%. That's obviously both the currency move and a stock price move. Appreciate that, the perspective there. And it's also good to understand that the benefits of the flexibility there of, obviously, if you are forced to cross that spread, what that can mean for the portfolios. You made some comments there about Russian securities, through the GDRs. What are we seeing today in terms of the trading there? Because of the sanctions overnight, there's very limited trading in those securities. And many of the stock brokers that we've been speaking to have actually said, they're not going to be trading those at this point, until they understand the impact of sanctions upon those securities. Well, and that's a good point there. A lot of information, obviously, that all market participants are digesting based on the situation on the sanctions that are coming out. And certainly Dimensional is always gonna approach that with flexibility, when we think about what we're ultimately gonna go out there and trade and how we're gonna trade. Absolutely. So, we've heard from APAC and we've heard from our colleagues in EMIA. So, we're gonna pass it over to the US now. And we're gonna bring on Dave Plecha, Global Head of Fixed Income and Jed Fogdall, Global Head of Portfolio Management. And we're gonna talk about what's happening within these particular markets within the US. Now, Dave, I wanna bring you on the program first, thanks for taking a couple minutes out of your day to join us. Happy to be here. All right. So, as I mentioned, we're switching gears from equity to fixed income and you've been managing fixed income portfolios at Dimensional for many decades now. So, tell us what's happening in the bond markets in the US. So, Courtney, if I had to describe yesterday, I'm gonna use a little bit of a metaphor. Say you wanna get a little bit of exercise this weekend and you're gonna go out and do a walk or do a run. You're probably gonna do one of two types of routes. You're either gonna do some sort of loop run or you're gonna do an out and back. Run to a point, turn around and come back in the exact same way. Yesterday's bond market, I would call it, it did an out and back. So, if you looked at the activity first thing in the morning, there was a sharp rise in treasury bond prices across the board. If you looked out at the 30 Year Treasury Note, it was two bucks, 2 points on a price of around 100, that's 200 basis points. Think about that, if we're in a yield environment where the yield on the 30 Year Treasury is just a little over 2%, call it 2.3%. You have to sit out a full year to earn 2% of income. You got 2% of price appreciation in the opening minutes of the market yesterday. So, it was across the board. The media folks will often refer to this as flight to quality or a risk-off trade. People in times like these, will go to the Treasury Bonds. So, for the treasury market and portfolios that were holding government bonds, they were experiencing a positive return in the morning. And the corporate side is the opposite. So, you think about a corporate bond, think of it as a Treasury Bond with a credit component. Well, the Treasury component of the corporate bond was doing well but the corporate component was not. So, we saw credit spreads widen across the board, not by a huge amount. This did not look like anything of March of 2020 or anything like that. But let's say across the board, corporate credit spreads widened by about five or six basis points. So, what does that mean to a corporate bond price? Well, it depends on the duration of your portfolio. So, just a quick rule of thumb, multiply that change in yield or those credit spreads by the duration. So, if you had a corporate bond portfolio with a duration of five, maybe that would've had about a 25 cent, 25 basis point impact. But across the board, investment grade portfolios were up in the day because the surge in treasury prices more than offset the widening of credit spreads they were trading on. So, that was out part of the day. And then the rest of the day was the back part. We saw the treasury yields, the prices began to work their way back by the end of the day and credit spreads began to narrow back by the end of the day. When you got to the end of the day, treasury prices were up a little bit and credit spreads were a little bit wider but if you just looked endpoint to endpoint, look at the NAV, it was up a penny on the day. Our short duration credit strategy was up a little bit on the day. So, I often get in discussions with people about what if this happens and what if that happens in the world and so we're talking about, well, what part do you think is priced in? Or do we think most of this is priced in. Yeah, there was a lot of in day volatility, of course but if you just looked endpoint to endpoint, end of day, Wednesday to end of day Thursday, it wouldn't been a remarkable day in the bond market in either direction. It would've seemed... You could reasonably conclude that the market had more or less priced in what was about to happen. I appreciate that perspective, Dave. Now, what about globally? Can you speak to that? Similar. Similar story across the board, war broke out in Eastern Europe but if you looked at the sovereign bonds in the Western part of Europe, they were up. German government bonds were up, the benchmarks there, through most of the rest of the world is not the 30 year, it's mostly the 10 year sovereign bonds. In Germany, France, Netherlands, Austria, all the the Western European sovereign bonds were up about, say 60 basis points on their 10 years. Credit spreads were widened there too. There were probably two sectors we saw a little bit more selling pressure on, the energy sector and then the European banks. Their spreads widened out more than the average that I was talking about, the five or six basis points. But by the end of the day, again, it was mostly an out and back for the rest of the market as well. Now Dave, I wanna bring up a point you mentioned in the beginning of your segment and that's March of 2020. So, can you reiterate that for the viewers? I think it's really important to point out because I think in times of volatility, like we're experiencing and we did in March of 2020, a flexible approach really comes into play. That's for sure. When we dissected March of 2020, we did a lot of that and we looked at the transactions 'cause, our trading advantage was much greater. The numbers were shockingly good when we look back at that. And at first I was surprised by that and then I thought, well, maybe I shouldn't be so surprised because if flexibility helps you in normal markets, flexibility really helps you in highly volatile markets. So, in the end, that approach, people often think, oh, it's a very volatile day, you must have been trading like mad. And that's actually not really the case. Most of the time when we have a volatile day, a real volatile day like we did yesterday, we actually say, let's hold back a little bit, let's let market settle down. And we have the flexibility to do that. Well, Dave definitely appreciate that perspective there and Court, we heard it from Mark out of EMIA, we heard it from Dave, this idea that when you're not forced to trade, when you're not forced to cross spreads, when you hit volatile times, again, that idea of flexibility really comes into play. Saw it in March 2020, saw it during this week with the conflict. And that's really been a hallmark of Dimensional over the years. Let's go ahead and chat with Jed Fogdall. And Jed, it's gonna be great to bring you onto the program here. We've heard from our colleagues out of APAC, outta EMIA, you heard Dave make some comments there from our Santa Monica office, looking at the bond markets and what we've seen. Let's get your perspective, as you think about the last couple of days in relation to how Dimensional's been managing portfolios. Yeah, thanks, Jake. I think what you guys started with, that the human tragedy of things like this, unfortunately, bad stuff happens in the world. And it's a fact of life when you're investing in global markets, that you have a job to do when these things are happening. And I think if we're talking about it then it's because anxiety is high and volatility is high and usually not in the other direction. So, from my seat, these are the times when I take comfort and I'm glad for the risk management that we build into the portfolio design. And whether that comes from things we talk about all the time, with respect to either diversification or some of the things Bhanu spoke about, with security selection, instrument selection, country selection, settlement mechanisms, all those risk management things that we think about ahead of time, prove their value in situations like this. So, I think that's one good thing about... Part of the good news, let's say. Now, again because it's a fact to life, our team, our processes and our portfolios have lived through crises like this before. And what does that mean? Well, it means we've developed some expertise among the team and we've built some of that expertise into our process to be able to answer three questions that always have different answers but it's the same three questions each time. It's, what is happening? What's the impact and what can we do? And in this case, there was some telegraphing of what might come down the pipe but we didn't really know what the impact was gonna be and had some ideas of what we would do but had to be, again, back to what Dave was saying about flexibility. You have to decide, are you going to buy or hold or sell or are you gonna have to do something with either, cash management, you're gonna have to do something with evaluation, liquidity considerations, all of the things that go into managing a portfolio, you have to deal with those in real time and make decisions in real time. And that's where that flexibility comes in. You have more degrees of freedom to respond in the way that events dictate and that's proved valuable over the years in all of the different scenarios that we've encountered. Yeah, Jed appreciate that perspective there. And I like the, I'll say relatively simple approach, right? Answer some basic questions that you outline. And that's the way that we've done that in previous events as well. I don't know if you can talk about any of the previous ones over the last decade or two, just to give our viewers some perspective because obviously, these types of events have popped up. The actual event is different but the impact on markets, increase in volatility, maybe what happens with liquidity, even challenges accessing some of the markets or the local exchanges. Could you give a couple of specifics there for our viewers of how we've handled it previously as well? Yeah. Going back, you could go back to 9-11, which is towards the beginning of my career and the impact of that and the shutdown of US markets. When we saw the earthquake in Japan back in 2011, that was a big deal for global markets. Dave mentioned March of 2020. Of course, the global financial crisis had lots of implications for a long time across lots of asset classes. So, what I said before, you have very different answers to a similar set of questions and developing that expertise and developing that discipline to answer those has been important to surviving through and designing things that are robust to those kinds of events. Exactly right about that, right? You wanna have a process that you can put in place, regardless of the event that's gonna pop up and certainly a manager with a lot of experience handling these different types of situations, really in markets all around the world, in both the equity and the fixed income markets. Jed, let me ask you just, we've got a lot of our clients that are tuning in, they've obviously maybe got their own clients as well, investors, plan participants, whoever that may be. When you think about the message from Dimensional, from what we've seen this week, what would you wanna leave them with? Couple things I think are important. One, when you heard Mark and Dave talk about how markets have moved over the last couple of days, it's yet another example of how difficult it is to out guess what market prices are saying and doing and how difficult it is to make a call and make tactical decisions in your portfolio. It also highlights maybe, some of the costs of making those changes when volatility is high because spreads are wide and because prices are moving a lot and you could end up hurting your portfolio. But probably the thing, if you're already convinced about those elements, probably the thing that I'd hope to leave clients with is I hope you can do similar to what we do, in terms of having a disciplined process to make decisions, having the discipline to implement those decisions and stick with them through tough times. And I think that's key to consistency, that's key to risk management and it's what we do with the portfolios we manage. Well, I think that's a good message there, Jed. Just the ability to have perspective on any event that's gonna pop up, have a process, have a system, have something you put in place, it's gonna help maintain that discipline because as we know, trying to figure out what's gonna happen in the future, when to get in, when to get out, you even look at something like US markets yesterday. I think when all of us woke up and read some of the news and you looked at futures, we saw where the market started and then where it finished up. And it's hard to make a prediction on any given day, what is ultimately going to happen. So, a great message there. Jed and Dave, thank you guys so much for joining us on the broadcast today. Thank you. You're welcome. Yeah, that's exactly right. And I think that really reiterates the point of David Booth's recent quote that he put out, statement that he said. And so, I'm gonna go ahead and read it. We'll go ahead and get it full screen. "In times of instability, it is essential to assess whether markets are functioning properly. Right now, markets are behaving as we would expect them to. They are open, trades are executing, buyers and sellers are coming together and setting prices. The world has seen many crises during more than 50 years studying markets, which has taught me that uncertainty and volatility are part of investing. Time and again, markets have rewarded investors willing to focus on their goals and stick to their long-term plan." That's exactly what you and Jed were talking about, Jake. Yeah, that's exactly right. And look, David is obviously a long time in investor. He's always got really good perspective. He's been through many major events before Dimensional, here at Dimensionally. He's always got that higher level perspective of what you wanna be reminded of as an investor. So, it's great to see the quote there from David and really appreciate him always putting something out like that. Absolutely and we wanna reiterate too, again, as we said in the beginning, our thoughts are with everybody that are affected by the crisis in Ukraine right now. Well, that's exactly right. Again look, we're a global asset manager and we wanna be able to give perspective to our clients on what we're doing and how we're handling the situation and hopefully hearing from our global investment team, we were able to do that but you're right. We said it at the top. We've reiterated again. Incredibly, incredibly challenging situation in Ukraine. So again, just want to send our thoughts out to everybody that's affected by it. Absolutely and we wanna mention another webcast we're going to have next Tuesday, March 1st. And this webcast is available to end investors. So, US clients can invite your client to this particular webcast. And Jake and Mark are gonna talk about recent headlines. We're gonna talk about geopolitical issues, like we've discussed today but I know you're also gonna cover some other items that have been on investors' minds around some anxieties and fears of what's happening in the market. Yeah, you look at the start of 2022 and there's really no shortage of events that have taken place. Look, there's always major events that are happening in markets but as we've kicked off the year, we've got what we've just been discussing here. Major geopolitical events that are going on, saw rising rates. We've been dealing with inflation, we've got some increased market volatility. So, a lot of information that investors are having to digest here in the first two months of 2022. So, thought it might be good just to hop on a broadcast and give some perspective on what we're seeing there, reinforce a lot of the points that obviously, you know you're gonna hear from Dimensional but we hear from our clients that sometimes it's helpful for us to speak directly to the investors. So, if it's helpful for you all to direct your clients to that, wanted to make sure that you were aware of that as we look forward to Tuesday of next week. Absolutely. So, end investor for US and Canada and that registration link will be available in the thank you email from this broadcast. Any final thoughts as we close today, Jake? No, we just hope that the last couple of minutes give some good perspective on our ability to manage through these different situations. As we mentioned, we've got trading floors all around the globe. We've got portfolio management all around the globe. We've been through situations like this before. And I really like what Jed said, just that having that process leads to the discipline. That's certainly the approach we take here at Dimensional. Tough situation but we know that tough situations are gonna come about in the future so you wanna make sure you've got a plan when they do come up. That's exactly right. Well, as Jake mentioned, thank you so much for tuning in. We hope that you found the last half hour helpful.