Statement on Exclusion of Russia From Investible Universe

Posted by Vident Financial on 3/3/22 10:14 AM

As a result of recent events involving Russia and the Ukraine, and an analysis of perceived investment risk and reward as discussed below, Russia has been excluded as of March 2nd, 2022, from the Vident Core International Equity IndexTM (VIEQX) investable universe.

The Ukraine crisis has driven both the Russian Ruble and broad Russian stock indices dramatically downward. This raises the issue of whether a value-oriented approach should continue to hold or even significantly increase holdings of Russian stock indices. We would caution against automatically following such an approach: valuation isn't everything. Although the data supports the idea that allocating capital using a valuation discipline has historically tended to be additive, the pattern is not universal. Using valuation factors at a country level, for example using factors such as aggregate valuation of broad stock market indices, shows that low valuation historically correlates with returns. Also, interest rate yields have been additive in that high interest rates compared to history tend to reflect the high levels of fear and pessimism that can represent buying opportunities.

Valuation alone is not enough: risk factors also need to be taken into account when making allocation decisions, because sometimes a nation is so at odds with the fundamental principles, which tend to enhance returns over the long run, that sell-offs and compressed valuations are more likely to represent a trap than they are to represent an opportunity. In cases like this, whole nations (and not just individual stocks) become "value traps," situations in which investments deceptively appear to be prudent when one looks only at price, but in reality are not prudent when risk levels are taken into account. In these cases, on sale is not on sale enough.

Russia exhibits many of the warning signs of not being worth the risk, even after the recent massive discounts in valuation. The fog of war makes what's ahead even more obscure than usual, but there are patterns in history that can help guide those who allocate capital. One of them is that there are certain levels of corruption, weak rule of law, abuse of property rights and of human dignity and productivity, and dysfunctional leadership, which make it impossible to allocate capital with confidence, at any price.

To be clear, this is a statement of risk management, not a political statement or moral declaration. Individual investors have differing levels of approval or disapproval of different countries, and different practices when it comes to whether to boycott countries or not. That is a matter of individual investor conscience and involves both moral and political considerations. We are not arguing that Russia should be excluded from a universe of investible countries due to such considerations. That’s not our job. Our job is to help assess national investment environments in a way which accounts for both principle adherence and pricing dynamics in VIEQX. Looked at that way, we do not believe that Russian markets, even at their current compressed valuation, are a prudent risk and as of today we are excluding Russia from the VIEQX investible universe.

The opinions expressed herein are those of Vident Financial at the time of publication and are subject to change. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the information described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. Recipients should not rely on this material in making any future investment decision.

Investors cannot invest directly in an index. Indexes are not managed and do not reflect management fees and transaction costs that are associated with some investments. Past performance does not guarantee future results.