A number of European mutual funds that focus on investing in Russia have suspended redemptions and more are likely to do so, Fitch Ratings says.
The rating agency reported that 10 European mutual funds that are focused on Russia or emerging markets more generally have suspended redemptions so far. The funds represent about €4.2 billion in assets under management (AUM).
“We believe further Russia-focused funds may suspend redemptions, driven initially by an inability to trade portfolio securities,” the Fitch report said.
Fitch noted that funds can temporarily suspend redemptions due to a lack of liquidity or if events, such as a market closure, prevents funds from trading their portfolios.
“The closure of the Russian stock exchange, for example, could force funds with domestic exposure to suspend redemptions due to an inability to trade effectively,” it said. “Similarly, if there are issues affecting the ability of custodians to execute cash flows, notably where assets are sub-custodied in Russia, then operational issues could prevent funds from trading effectively, leading to gating.”
“A surge in redemption requests from investors could quickly compound the situation,” Fitch added. “Sudden or severe performance deterioration typically precipitates investor redemptions even in normal market conditions. Given the extreme geopolitical uncertainty, redemption activity in Russia-focused funds could increase materially.”
In addition to the funds that have suspended redemptions, Fitch said it’s also aware of two fund firms that have adopted “swing pricing” — a mechanism that adjusts fund prices based on redemption activity, so that redeeming investors bear the cost of the fund liquidating positions to meet redemption requests.
Overall, Fitch said that Russia-focused funds in Europe had about €5.7 billion in AUM as of the end of January.
Emerging markets funds had €640 billion in AUM, with an average exposure to Russia of about 4%, it reported, citing data from Lipper for Investment Management.
According to Morningstar, there are a handful of Canadian emerging markets mutual funds with exposure to Russian equities too.
Fitch said that while European emerging markets funds may be temporarily unable to trade their Russian holdings, this shouldn’t affect overall fund operations, as their allocations to Russia tend to be low.
However, there are individual funds with larger exposures, in some cases up to 25%, which will be more likely to implement “extraordinary liquidity measures,” it suggested.
Emerging markets funds direct exposure to Ukraine is also low, Fitch said, at an average of just 2% of AUM.
Given that the European asset management industry had total AUM of €22 trillion at the end of 2021, Russia-focused funds and even emerging markets funds are a tiny share of the industry, Fitch noted.
As a result, for most funds, the conflict is more likely to affect them through increased market volatility rather than due to the direct effect of sanctions or other measures, it said.
“The challenging conditions may lead managers to shift their focus to asset retention from asset growth, particularly if securities prices decline,” it added.
On Monday, Reuters reported that Dimitris Melas, MSCI’s head of index research and chair of the Index Policy Committee, said that MSCI is actively considering removing Russian listings from its indexes.
Russia comprises about 3.24% of MSCI’s emerging market benchmark and about 0.3% of the global benchmark, Reuters reported.
Separately, Moody’s Investors Service announced that it has placed the sovereign ratings of both Russia and Ukraine on rating watch for a possible downgrade due to the fallout from the conflict.
S&P Global Ratings downgraded its ratings on Russia on Feb. 25 and on Monday lowered ratings on several financial institutions and related entities, citing the “increased geopolitical and economic risks.”
“In our view, the escalation of Russia-Ukraine tensions, Russian operations in Ukraine, and widening of sanctions against Russia could lead to conditions that eventually destabilize Russia’s economy and financial system,” S&P said in a research note.
Restrictions on Russian banks and the central bank will “likely constrain Russia’s long-term growth prospects and potentially make the country less attractive to investors in the medium to long term,” S&P said. “We understand that further sanctions could be contemplated, which could further limit Russia’s access to the global economy and financial markets and hurt its financial sector.”
Additionally, these measures could intensify volatility in the Russian stock market, which is already down more than 40%, and the rouble, “which in turn could erode banks’ profitability and capital positions,” S&P said.
“We plan to assess the impact of any further potential sanctions on the Russian financial sector as soon as we have details,” S&P added.