Much of the commentary about the Ukraine war’s implications for the investment-management industry has tended to be both immediate and narrow, particularly in discussions about the spillovers for different segments. By zooming out, however, some longer-term ramifications become more apparent for both public and private markets.
The war is amplifying and accelerating six important secular evolutions that were already taking place well before the first Russian troops invaded Ukraine. Indeed, on the eve of the invasion:
- Inflation was already a problem; the Federal Reserve was already behind the curve; it was losing control of the monetary policy narrative; and the days of massive liquidity injections were ending.
- With many policy options virtually exhausted by the enormous response to the pandemic, the possibility of stagflation for the global economy was already a risk; and, at the other end of the probability distribution of potential outcomes, the upside scenario of high growth and transitory inflation was declining.
- Persistent China-U.S. tensions, together with the pronounced politicization and weaponization of trade sanctions during the Trump administration, were serving as headwinds to continued globalization and liberalization of both economic and financial cross-border interactions.
- The need to intensify the battle against climate change was urgent, as was the realization of the complexities of the transitional issues, including the orderly replacement of fossil fuels.
- China and some other countries were looking for more ways to build bigger pipes around the Western-dominated core of the international monetary order.
- Driven by an enlarged set of stakeholders, companies were being pushed to take more seriously their social and environmental responsibilities, including starting to self-sanction themselves more away from harmful activities.
In addition to speeding up and intensifying these developments, the war has also increased the scope for their interactions, making the universe of potential outcomes not just much broader but also more path dependent.
Ironically, the complexity of potential outcomes has a powerfully simple implication for the investment-management industry: a bigger migration from public markets into private ones such as private equity, venture capital, private credit and real assets.
The drivers here go well beyond the irony that, in public markets with still-repressed bond yields and the certainty of sizable negative real return on cash, equities remain the asset of choice despite the deteriorating outlook for economic and corporate fundamentals. Indeed, much of the essence of “risk-free assets,” and the comforting correlations associated with them, has been eroded.
Private markets offer the potential for flexibility that is needed in this more uncertain world. This includes a broader range of investment techniques, the scope for structural resilience that comes with explicit collateralization and smart structuring, a more appropriate pricing of liquidity, and the greater structural ability to stay in the trade during periods of unsettling volatility.
The increase in demand for private markets will need to be met by a broader and better choices set offered by the industry. Investment-management firms will need to bring to the table a greater degree of cognitive diversity, more of a multidisciplinary mindset, a more global footing (including in more developing countries), and good local presence and solid execution capabilities. Legal jurisdictions will matter much more, as will the compliance infrastructure to navigate a world of ballooning primary and secondary sanctions.
In the world in which massive liquidity injections shielded investors from virtually any and all headwinds, public markets offered significant potential, especially when levered. Meanwhile, the breakdown in the traditional correlation matrix for stocks and bonds, together with the repression of volatility, only enhanced the upside.
Russia’s invasion of Ukraine is speeding up the move away from this world, a process that had already begun. Increasingly, investors will need to consider larger allocations to private markets, both to maximize returns and contain risks. And the industry will have to adapt in both offerings and management.
Reporting by Bloomberg.