While Russian stocks and bonds are now considered essentially worthless in the wake of Russia’s invasion of Ukraine, it’s also important to consider that investing in autocracies like Russia carries a greater risk, contends an article in Morningstar. Investors may earn returns for a period of time, but those profits are always at the whim of whoever is ruling the country—a person who is often creating rules solely to retain their power and enrich themselves.
Though the Russian invasion of Ukraine is a pretty extreme example of what can happen to investments in an autocracy, it’s more common for investors to run into the “rule of law.” Despite careful consideration before making an investment in an autocratic country like Russia, if someone cheats you out of your investment, there is no recourse, either in the courts or the media. And of course, the sectors and strategies that carry less risk in Russia are also far less profitable.
There’s also a lack of transparency in autocratic or authoritarian regimes, the article continues. Even teams that visited Russia in late January, such as BlackRock’s emerging-markets team, didn’t think the country would invade Ukraine. And even if they had been in a position to ask anyone in power what was going to happen, it’s unlikely they would have gotten the truth. Many investors believe they can approach markets in autocratic nations the same way they approach the market at home, and that’s unfortunately a naive way of thinking.
Investing in Russia, which usually only amounts to a small portion of a diversified investor’s portfolio, is risky enough, but investing in China could be even riskier given the high percentage of mutual funds and stocks that have a large direct or indirect exposure to the country. Russia is 3% of most benchmarks; China is 30%. And as China becomes more nationalistic, it’s going to affect how they treat foreign investors. Many observers have compared Putin’s actions in Ukraine to China’s long-standing conflict with Taiwan, and last year the Chinese government enacted restrictions on internet and private education companies, resulting in massive losses for U.S. investors in Chinese equities.
Investors should be examining their portfolios for exposures to autocratic countries, including exposure that may be buried in an off-shore company that does business in these nations. For example, many energy and natural-resources companies partner with state-owned entities, making it complicated to untangle from a regime rife with corruption, human-rights violations, or engaged in war. And while these markets sometimes have periods of booming outperformance, the geopolitical risk is an added layer to any money you might make, the article contends. “The question directly confronting investors is whether it is really sustainable long term to be investing in these kinds of countries,” says Jon Hale of Morningstar. “It is a systemic risk that we are all contributing to and that we should be paying more attention to.”