War in Ukraine puts active investment back on the agenda

In addition to its impact on the global economic order, the invasion of Ukraine will accelerate the energy transition and force investors to be more selective.

The war in Ukraine is shaking up the world and profoundly transforming the world order patiently constructed after the Second World War. Beyond strategic or military considerations – and whatever the outcome of the conflict – it seems clear that this war in the very heart of Europe will have long-term consequences that will durably alter the environment to which we have been accustomed for over thirty years. And investors will have to adjust.

Reversing globalisation

One of the most profound consequences is likely to be a reversal of the trend towards globalisation and a sharp decline in world trade. Indeed, as this conflict has clearly shown the existence of distinct geostrategic blocs, it is likely that states will do everything to reduce their dependence on foreign countries. They will radically review their supply sources – a trend that has already begun in the wake of the COVID pandemic – and above all repatriate the production of essential goods to their immediate vicinity. At the same time, competition for essential resources is also likely to reconfigure the world into distinct zones of influence around major patron powers and lead to a shift from global to regionally limited trade.

On the road to energy independence

Above all, this crisis has clearly shown the drawbacks of our energy dependence on a small number of supplier countries (in this case Russia for Europe) and therefore the increased need to accelerate the energy transition to a low-carbon economy. While this movement was already underway in Europe, the banning of Russia has clearly increased the pressure on governments around the world to achieve the energy independence that only migration to clean energy sources can provide. It is therefore certain that investment in this sector will rapidly increase, as will the race for technological innovations to make it more competitive with fossil fuels. The acceleration of this secular trend will thus give rise to a multitude of new investment opportunities that are as yet unsuspected.

ESG criteria to be reviewed

This crisis has also demonstrated the limits of ESG policies, which have been severely shaken by Russia’s aggressive attitude. Indeed, it has put the spotlight back on investors’ legitimate questions about investments in all authoritarian regimes, in addition to Russia, which has rapidly become a pariah subject to an avalanche of sanctions. The question then arises as to what position to take on investments in other countries under the yoke of authoritarian regimes that ignore the human rights that are inseparable from our values. After focusing on the E of environmental and energy issues, ESG management will undoubtedly have to look more closely at the other two letters, in particular societal criteria, and especially respect for universal values.

Passive investment shows its limits

In this new environment, the contours of which are still fluid and the consequences of which are not yet clear, agility and selectivity should become key values for all investors. Gone are the blessed days when buying an index product was enough to perform! Indeed, as the largest listed companies have largely benefited from globalisation and therefore dominated the market over the last 10 years, passive strategies have gradually become the darling of the markets. Today, it is very likely that this magic recipe has run its course and that investors will be forced in the future to be more discerning in their investment strategies. Although passive investing has long offered a satisfactory solution at a lower cost, it lacks by definition selectivity and judgement, whether on the impact of the new world order on the profitability of the former winners of globalisation or on the ESG criteria that these large groups apply in authoritarian regimes.

The necessary return of selectivity

Indeed, passive investing is essentially based on the idea that investing in any index is more profitable and less expensive than using active strategies. Admittedly, as many active investment houses have consistently underperformed their benchmark, this assumption of lower cost investing seemed to be validated by experience. While the bias of studies that confirm this (selection, size and style bias) can be widely discussed, this is not the point here. On the other hand, in the future, with the emergence of a more fragmented, and therefore less globalised, world, it will be much more difficult to succeed in applying such an indiscriminate strategy, focused on the largest listed companies. This is likely to be true both for the performance of different strategies and for the governance criteria that investors now want to see applied to the selection of stocks in their portfolios.

After a long period of almost unhealthy obsession with management costs rather than performance net of fees, we could well see fundamental research and active investment based on real choices regain a lustre that has been tarnished for some years. In a way, it would be a return to true values – in every sense of the word!