I bought a Russian equity fund more than a week ago when the Russian MOEX stock index crashed over 40% in a single day after Russia invaded Ukraine.
What happened last week can best be described by this picture.
The fund lost 78% of its value from my purchase price within 1 week. I doubt anyone can beat this loss record in terms of speed and percentage loss. I am a real champion in this regard. If the market is making you feel like an idiot this year, then my champion record would be a good consolation to you.
Money lost in such speed and magnitude carries lessons to be learnt.
I looked back at the reasons I bought the equity fund in the first place.
- Odds are on my side for a quick rebound after a 45% crash in a single day. Buying when others are panicking is an edge that never dies.
- The booming commodity prices are a tailwind to Russia's commodity-driven economy. Russia stock index's bottom ranking among global stock indices will give the eventual rebound more room to move up. After all, the top 2 performing stock indices this year, Brazil iBovespa and Saudi Tadawul, have similar commodity-driven economies like Russia.
- Valuation of Russian stocks, in general, was very attractive. It was easy to find blue-chip Russian stocks with a single-digit PE ratio and a dividend yield of more than 6%.
- A diversified fund benchmarked to a stock index does not drop to zero. Individual stocks can drop to zero but not a diversified portfolio of value stocks. Chances of recovery is high, particularly when price is down so much and valuation is so cheap. Besides, stock indices tend to go up over the long term.
The reasons were valid at the time of purchase on 24Feb2022, Thursday. However, the turn of events made me very worried. The headlines news I read on the following Monday were alarming. Western powers announced sanctions on Russia and froze Russian assets. Russia's foreign exchange reserves were frozen by G7 countries.
I am not trying to defend Russia. I am trying to put myself in Russia's shoes and anticipate how they will react. Having your reserves frozen is like having your hard-earned savings taken away just at the moment when you need to use the savings for emergency use. How will you react to hostile parties who did this to you? If you could, retaliation will be a natural response.
If Russia were to retaliate, my original assumption that a stock index does not drop to zero is false. In fact, stock indices did fall to zero in financial history before. Where did it happen? In Russia where investors lost EVERYTHING when the communists took over in 1917. The stock exchange remained closed for the next 75 years. The investments were gone for good. 10000-times gain for an investor is useless if his assets are confiscated. An investor's worst nightmare is when his private property rights are violated.
Cheap valuation, buying on the cheap is irrelevant if you have to question whether your property rights are going to be respected.
Indeed, my deepest fears were realized as an investor when I read this headline news before the London stock market opened on Monday.
I am not sure if Russia will really carry out this threat since the West can strike back with greater force by extending the freeze on Russian assets into outright confiscation. Several western businesses and well-known brands have exited the Russian market since the Ukraine invasion started. I am sceptical they are doing this to show support for Ukraine. It is probably they are fearful of what will happen to their own assets that are under Russian jurisdiction.
Russian Rouble crashed 30% against USD on Monday morning(28Feb2022). The crashing rouble and the risk of Russian retaliation were enough to convince me to cut my risk exposure to the Russian equity fund that I bought only a few days ago. I changed my mind about the purchase overnight.
I started selling when the London market opened on Monday and by Tuesday, I had cut my position down by almost 85%. Within those 2 days alone, the fund dropped 47.1%. The fund then dropped another 50% in the next 3 days after I cut my position. Even though the original position size was small and the position was cut fast, the amount of money lost was still painful given the magnitude and speed of the fall. With the benefit of hindsight, I would have done better if I had simply sold everything on the first day when the market opened.
One lesson learnt is that in times of war and political upheaval, the normal rules do not apply. As an investor, it makes me uncomfortable to see property rights being violated. To the Russian people, the outside world has become uninvestable because their assets have been frozen. For foreigners, Russia has become uninvestable due to sanctions and fear of Russian retaliation. In fact, Russia has already started to respond in kind to the sanctions imposed. Foreigners are banned from selling Russian assets temporarily. Russian bond coupon payments to foreigners have been banned. The ordinary Russian man in the street suffered worse in this economic war. Russian Ruble has depreciated by about 44% against USD in the past 2 weeks (21Feb2022 to 4Mar2022). With the Russian economy cut off from the outside world by sanctions, the supply chain disruption will drive up daily expenses through goods shortages. It is a very hard time for the people with massive wealth destruction and fast-rising inflation happening at the same time.
In this kind of hostile environment, financial assets no longer count as wealth because they can be forcefully taken away unjustly but legally. Wealth can be destroyed in quick time through massive currency devaluation within days. One still has to contend with ever-rising daily expenses caused by goods shortages and currency devaluation. You can be an ultra-rich person today and lose most of your wealth tomorrow with no time to react. In this situation, the best asset is human capital. Each individual has his own set of knowledge and skillset to earn a living. No one can take his knowledge away.
I read that Jewish parents, particularly asset-rich ones, who witnessed the Holocaust and had their assets unjustly taken away by the Nazis encouraged their children to become skilled, high-paid professionals because no rogue dictator can rob assets that reside inside their heads.
To survive in the worst-case financial scenario when a person loses 100% of his financial assets, he should be able to answer this question with confidence:
What special expertise and skill-set do I have to be of service to other people to use my labour to earn an honest living?
Unfortunately, age and bad health will catch up to all of us eventually. We will lose our ability to work eventually. This is unavoidable. One solution is to be kind and generous to as many people as you can while you are able to so that one day when you really need help, they will return the favour. Even if they turn out to be ungrateful, the process of being kind and helpful will make a person happier. There is nothing to lose in being kind. At the very least, do not be mean. Always treat other people courteously with respect no matter who they are.
Most people will be helpful if it does not involve too much sacrifice. To be fair, if a person has not put in enough sacrifice himself to help others in the first place, he should not expect too much in return. If he expects help when he becomes a useless burden, then be a parent (but try your best to be self-reliant as far as possible). Again, there is no guarantee that children will be filial but the process of raising them is worth the sacrifice even if the outcome is bad. I have never regretted being a parent.
During chaotic times when rogue governments confiscate your assets, the worst form of asset to own is real estate, particularly in hostile territory. The illiquid real estate is stuck in unfriendly territory and impossible to move out. I hope fellow Singaporeans will bear this risk in mind before they commit too much of their net worth snapping up properties in a neighbouring country with a history of testy relationships with us.
Some financial assets are more useful than others in chaotic times. In the past, we have physical Gold and Silver. Today, we have digital cryptocurrencies like Bitcoin. These assets share some common characteristics. They cannot be confiscated by central authorities. Their value cannot be destroyed by currency devaluation. I personally prefer Bitcoin because it is in digital form and is easier to handle logistically than Gold. Earlier, I wrote that if Bitcoin existed during Holocaust, it would be a wonderful asset for rich Jews to protect their wealth.
I believe Gold/Silver and decentralized cryptocurrencies like Bitcoin should have a place in our portfolio since the risk of a Russian-like crisis hitting us cannot be dismissed, however unlikely. You never know.