Thought Leadership in Action

With the Feb. 24 Russian invasion of Ukraine came a humanitarian crisis that has led to global condemnation of President Vladimir Putin’s regime. The outcry from the general public and lawmakers led to severe sanctions against Russia. Supply chain disruptions and soaring prices for energy, food and commodities have been seen in the months following the invasion.

Pressure for numerous state and other public pension funds to divest from Russian assets came soon after the outbreak of war. Meanwhile, fund managers quickly found themselves struggling to offload holdings in an arena of low Russian bond liquidity, unreliable pricing and restricted access to the Russian market. The result has been a headache for those trying to figure out how to divest from Russia.

Cut Off From Assets

The U.S., European Union, U.K. and others were swift to slap Russia with wide-ranging sanctions after its invasion of Ukraine. They imposed asset freezes, travel bans and other restrictions on Russia. Sanctions blocking Americans from engaging in transactions involving Russia’s central bank, finance ministry and national wealth fund came within a week of the attacks on Ukraine. Together with Britain, the U.S. announced restrictions that would effectively expel Russian banking assets from both countries.

 Russian markets ceased trading the day after the invasion of Ukraine as shares were plummeting. When it reopened a month later, short-selling was banned, and foreign investors were prohibited from selling assets, all in an effort to curb extreme volatility and retaliate against Western sanctions.

Indexes Dumping Russian Securities

With Russian stocks and bonds being virtually inaccessible, it quickly became impossible to assess their true value, and they were removed from major benchmarks. MSCI Inc. was among the first to cut Russian equities from its popular emerging markets indexes, noting an overwhelming response from market participants who saw the country’s equity market as “uninvestable.” Others followed suit as Moscow became more isolated from financial markets.

Under normal circumstances, changes to indexes are planned and announced with plenty of notice, often being carried out on a regular schedule. In some cases, weightings are gradually adjusted to avoid significant impact to the broader market. In this unprecedented situation, Russian assets are essentially being written down to a zero value and then deleted. It’s unclear when, if ever, funds will be able to sell their Russian assets. This presents an interesting dilemma for securities like global exchange-traded funds and emerging market ETFs, for example, because they may be stuck holding assets valued at zero that have been removed from the benchmark they follow, potentially causing a tracking error.

Demands on Public Pension Funds

Lawmakers around the U.S. and at just about every level of government have called for pension funds to divest from Russian investments. While this won’t have much of an impact on the funds themselves, as Russian-domiciled typically make up only a fraction of 1% of public funds, the collective sum of money could be large enough to send a message, with CalPERS and CalSTRS the largest U.S. pension funds with about $1.7 billion in combined assets.

 While some states have taken swift legislative action to divest, complex legal structures make it difficult for custodians and managers to quickly dump assets, and most of the pensions’ Russian securities are tied up in index funds. Like every other fund, they are limited by restrictions on the Russian market and would face difficulties finding a buyer. As bipartisan efforts to remove these securities from the books of public funds continue, it may be a while before they’re able to do so.