
5 minute read
Extraordinary Event
from CIC Yearbook 2022
by Consilium
Enhanced due diligence for an extraordinary event, Q1 2022
Nature of the EDD flag
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Consistent with its written policies and procedures, the Consilium Investment Committee (CIC) reviews all recommended investments on a quarterly basis against a combination of investment performance, quantitative fund metrics, and other qualitative factors
During the first quarter of 2022, several fund managers were flagged for enhanced due diligence under the following criteria:
1. An extraordinary event which has resulted in the exclusion of Russian securities from Emerging Market Funds and Index Funds as Russia proceeded to invade Ukraine.
The management of Dimensional and iShares were directly impacted by this throughout the quarter.
Russian Invasion
On 24 February 2022 Russia invaded Ukraine in a major escalation of the Russo-Ukrainian conflict that began in 2014. The invasion triggered unparalleled sanctions on Russia from the West and since February there has been a growing number of international corporations divesting their Russian businesses and fund managers reducing/removing their exposure to Russia. The U.S. have led the effort to isolate Russia’s economy, especially by hindering Russia’s ability to use the U.S. dollar, bringing it closer to an official default on its foreign currency debt.
The war has produced a supply-side shock for Europe and put extreme price pressures on a range of commodities and significantly increased fears of prolonged shortages, further supply-chain issues, and greater inflation feeding into the idea of an economy facing stagflation Europe’s ability for a sustained economic recovery after the pandemic is now waning as the ECB looks to follow the Federal Reserve in tightening monetary policy at a faster than anticipated pace to curb inflationary pressures that has been hindering business and household confidence, increasing the risk of a recession.
Russia’s stock market partially reopened to foreign investors on the 1st of April after closing on the 28th of February The majority of managers around the globe have effectively marked down their Russian holdings to zero and plan to offload the relevant securities as market functionality permits them to do Currently, the majority of market participants see the Russian equity market as un-investable and the selling of Russian securities by managers will be an ongoing process as they face severe liquidity and currency risk
Russia’s invasion of Ukraine is a grim reminder that geopolitical risk is a part of investing in global markets.
We contacted each of our recommended fund managers as part of our regular quarterly monitoring to see if the Russian invasion of Ukraine had any impact on their ability to maintain their fund mandate(s), and if so, what steps they took to mitigate this impact.
Extraordinary Event – fund manager mitigations
Dimensional Emerging Markets Value Trust
On 2 March 2022, Dimensional announced that their Investment Committee had removed Russia from their list of approved markets for investment.
Dimensional’s Investment Committee considers a variety of factors when evaluating a market’s eligibility for investment, which include, among others: government regulation, restrictions on foreign investors in that market, and market liquidity.
Dimensional noted they had previously reduced their weight to Russian securities in their emerging markets and global equity portfolios after sanctions were imposed in 2014 after the annexation of Crimea. In January 2022, Dimensional halted further purchases of Russian equities in response to rising risks of sanctions on Russia from the United States and other nations. After their Investment Committee’s 2 March decision, Dimensional is now divesting all Russian securities from portfolios as market liquidity allows.
As the Emerging Markets Value Trust is not managed with the objective of achieving a particular return relative to a benchmark index, during Q1 2022 Russian equities represented just 1.0% of the Trust compared to 2.73% in the MSCI Emerging Markets Value Index (net div. AUD).
We are satisfied that the exclusion of Russian securities in the Dimensional Emerging Markets Value Trust has had no material impact on the fund managers ability to maintain the fund mandate, which is to provide long-term capital growth by gaining exposure to a diversified portfolio of Value Companies associated with approved emerging markets.
iShares MSCI EM SRI UCITS ETF (SUSM)
Blackrock communicated that they have kept closely engaged with index providers and identified three primary objectives when managing index funds in accordance with their investment objective:
1) maintain tight tracking relative to the benchmark index;
2) minimize market impact around the index change event; and
3) minimize transaction costs
Blackrock advised they will continue to assess the best methods to manage impacted securities in their funds in accordance with these best practices.
On 2 March 2022 MSCI announced that the MSCI Russia Indexes will be reclassified from Emerging Markets to Standalone Markets status. This reclassification decision would be implemented in one step across all MSCI Indexes at a price that is effectively zero as of the close 9 March 2022.
MSCI noted that:
“During the consultation, MSCI received feedback from a large number of global market participants including asset owners, asset managers, broker dealers and exchanges with an overwhelming majority confirming that the Russian equity market is currently uninvestable.”
It added the current crisis has led to a “material deterioration” in the accessibility of the Russian equity market to institutional investors to the point where it no longer meets the market accessibility requirements.
At the time, iShares MSCI EM SRI UCITS ETF had exposure to three Russian securities in the materials sector totalling 1,590,555 shares outstanding and as the Fund seeks to track the performance of an index composed of EM ESG screen companies it seeks to comply with index construction decisions implemented by the index provider (MSCI). As such, the three Russian securities were subsequently marked down and effectively held no weight in the portfolio as of 20 June 2022 and will be disposed of as soon as materially possible
We are satisfied that the exclusion of Russian securities in the iShares MSCI EM SRI UCITS ETF has had no material impact on the managers ability to maintain the funds mandate of tracking the performance of their respective indices
Conclusion
We believe the Russian invasion of Ukraine can correctly be considered an extraordinary event and, as such, is an appropriate catalyst for this broad EDD review
However, the nature of this event – being confined to a relatively small proportion of emerging market securities – has been such that fund managers (and index providers) exposed to these securities have been able to continue to manage their funds and indexes effectively throughout the period (albeit requiring enhanced investor communications and, for many, a reclassification of the investibility of Russian securities)
The ability for recommended fund managers to be able to continue to deliver strategies in line with their published mandates was reinforced by their responses to our quarterly due diligence checklist When given the option to do so, each fund manager chose not to flag the Russian Invasion and their subsequent divestment from Russian Securities as an extraordinary event that would otherwise interfere with their ability to maintain the respective fund mandate.
Based on our analysis summarised above, we agree that despite the event itself being extraordinary, each manager has been able to demonstrate they have been able to act appropriately and in line with their respective fund mandates and indices they may follow.
June 2022
Disclaimer: The material contained in or attached to this report has been prepared based upon information that Consilium NZ Limited believes to be reliable, but may be subject to typographical or other errors. Consilium has taken every care in preparing this information, which is for client education purposes only. Although the data has been sourced from publicly available information and/or provided by the investment managers, we are not able to guarantee its accuracy. Past performance, whether actual or simulated, is no guarantee of future performance. This document does not disclose all the risks of any transaction type described herein, and the recipient should understand any terms including relevant risk factors and any legal, tax and accounting considerations applicable to them.
One or more of the author(s) of this report invest in the analysed security. The author(s) do not know of the existence of any conflicts of interest that might bias the content or publication of this report. Compensation of the author(s) of this report is not based on any outcome of this report.