Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Key points
The Trust has always invested in Eastern Europe, finding it a source of diverse opportunities. The Ukrainian crisis has been a shock and we have looked to understand its impact, for example in light of higher energy prices, on the entire portfolio. On a firm level, the Trust’s Russian assets have been written down to zero.
Through 2021 and in the current crisis, it has been vitally important to distinguish between the operational performance of companies and their share price performance. While share prices have seen significant volatility, companies have delivered well on their strategies.
There are still reasons to be optimistic about the European economy, but the companies we hold in this Trust have never relied solely on the European economy to make progress. We focus on companies with strong fundamentals in this challenging environment.
Market noise versus operational performance
2021 had been a relatively challenging year with plenty of volatility. A bounce back for recovery stocks in the first half of the year proved a test for the philosophy of the Trust. However, the second half of the year saw a more difficult operating environment for many companies as recovery stalled. The type of high growth, resilient companies with favourable end markets that we support moved back into the ascendancy.
It has been vitally important to distinguish between the operational performance of companies and their share price performance. Share prices have been volatile, but the companies we hold have executed well on their strategies. The past 12 months have been a formidable test for management teams, but they have rewarded our confidence. The turnover on the fund was just 18%.
It is not relative valuations that drive share prices, but fundamentals. The full year reporting season has helped provide a reality check, showing our companies are operating well even if share prices have been up and down. Nevertheless, we now need to consider the impact of the Ukrainian crisis.
The Russia/Ukraine conflict
The Ukrainian crisis has been a shock and we have reappraised the portfolio as the tragic events have unfolded. Since inception, this Trust has always invested a portion of its assets in Emerging Europe and we have invested in countries such as Russia, Turkey, Israel, Poland, the Czech Republic and Hungary through previous challenging periods. Since the crisis, no Russian assets have been traded and we have written down the value of all our Russia assets to zero. We consider this to be the most prudent way of dealing with a difficult situation. We continue to have exposure to stocks listed in Poland.
Elsewhere, we have talked to the management teams of other portfolio holdings to assess our exposure and found that it is very limited. The greatest risk to the remainder of the portfolio is that the conflict is likely to exacerbate the inflation problem, as energy and agricultural prices rise. We are also seeing rising costs in the steel sector because Russia and Ukraine are exporters of steel. We had thought that inflationary pressures would start to ease in the second half of this year and this makes the direction of inflation more uncertain.
Higher oil prices have historically been a tax on the global consumer. That spending has to come at the expense of something else. As such, it is likely to be a net negative for growth. The path of central banks is still unclear. However, we think it unlikely that they will tighten financial conditions materially in the face of slowing economy.
Pricing power
The rise in energy prices has been a visible consequence of the conflict in Ukraine, exacerbating mounting inflationary pressures. A buoyant economic climate floats all boats. However, a more difficult climate requires greater selectivity. That means backing businesses that are resilient in the face of rising prices and have growing end markets.
It is vital that the businesses we hold have pricing power and can pass on their raw materials costs. We strive to ensure they have scale in procurement, which means they are a priority customer for suppliers. Their supply chains are not as vulnerable to disruption. This should give a clear competitive advantage.
We also look for structural growth in demand for a company’s goods and services. This leads us to specific areas, such as digitisation or electronic vehicles. The crisis may accelerate progression to net zero, both as a result of greater urgency from policymakers, but also as consumers speed up adoption of electric vehicles. The EU has been a leader in progress towards net zero and this has generated myriad opportunities for investors.
The path ahead
There remains a lot of strength in the economy and considerable pent-up demand. Investors shouldn’t assume that the market is only going in one direction. It is possible that there is a de-escalation in the conflict and that inflationary pressures will abate. It is important not to be binary in our thinking.
The danger of aligning with growth or value, or to the outcome of a macroeconomic event, is that investors get whip-sawed by markets. We don’t know what’s going to happen, so we focus on companies with strong fundamentals in this challenging environment.
While we believe the economy is likely to keep recovering even in the face of this current crisis, we have never relied solely on the European economy to do well and for the strategy to make progress. As long as our companies are doing well, with buoyant end markets and sound fundamentals, Europe should prove resilient.
This material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are from BlackRock as of April 2022 and may change as subsequent conditions vary.
