Globalization in reverse for the fund industry: Are parts of the world now 'uninvestable?'

Published Fri, Mar 4 20226:38 AM ESTUpdated Fri, Mar 4 20228:24 AM EST

On Friday morning, the NYSE halted trading in three Russian ETFs: Franklin FTSE Russia ETF (FLRU), iShares MSCI Russia ETF (ERUS) and Direxion Daily Russia Bull 2X Shares (RUSL). These halts were for "regulatory concern": They are not suspensions or delistings. The VanEck Russia ETF (RSX) trades on a separate exchange and as of 7:57 a.m. ET is still trading. Several brief years ago, the growth of indexes and the corresponding expansion of exchange-traded funds allowed investors to put money into parts of the world that were largely inaccessible. Whole regions of the world and even individual countries suddenly became investable. Now, it seems, that is starting to reverse. Russian stocks no longer trade in Moscow, London, New York or Frankfurt. Two major index providers – FTSE Russell and MSCI – are deleting Russian stocks from their indexes and writing down the value of those stocks to zero. While markets have closed before and individual stocks have been delisted, it is unprecedented to simply delist and erase the value of stocks of an entire country. "This is a very difficult time for investors and fund managers," David Mazza, head of product at ETF fund manager Direxion, told me. Mazza manages the Direxion Daily Russia Bull 2X Shares ETF (RUSL), which provides two times the exposure to a market-cap-weighted index of Russian companies. "For years we were told to diversify. Now we are in a situation where we are told not to diversify," he said. "Now we are being told that markets that were once investible, are not," Mazza added. "It's like the retreat of globalization being played out in the ETF and mutual fund space." Running a fund with Russian stocks in it is so difficult Mazza has decided to cease trading the RUSL on March 11 and will liquidate the fund on March 18. Investors trapped in the Russian market It's a problem facing other fund managers as well. The Telegraph in London has reported that investors have 1 billion pounds trapped in the Russian stock market. "We have never seen this before," Ben Johnson, Morningstar's director of global ETF research, told me. "Russia will no longer be in those indexes. At the same time, the exit is barred. The asset managers have no means of liquidating positions." A representative from BlackRock, which runs the iShares suite of ETFs that use MSCI indexes in many of its funds, told CNBC in an email that "in MSCI's announcement, they will use a price of zero until further notice – so we will continue aligning/holding them at zero until MSCI provides further notice." What is investable now? The debate over whether Russia should be an "investable" market at all is part of a much larger discussion. Most agree that war would be a strong justification for a delisting from global indexes. But what about investing in countries that have not been delisted but are controversial? Investors have been debating about whether some markets are becoming "uninvestable." For example, there has been an active debate for several years about China. Some have argued that China's autocratic actions should be sufficient to convince some investors that China is no longer "investable." U.S. Senator Marco Rubio, R-Florida, has led calls to deter government pension funds from investing in Chinese stocks. While index providers have declined to delete Beijing from global indexes, they have made it clear that if there was a demand for an index of global stocks that excluded China, it could be easily provided. "What about activities below the level of war?" Mazza asked. "What level of aggression counts? Should we begin dis-investing in any regimes we don't like," such as China, he asked. A new global investment order? What will the new global investment order look like? The old order of simply investing globally by market capitalization may no longer have resonance for many investors, even if they remain in index funds. Dave Nadig, chief investment officer and director of research of ETF Trends, cautions that the Russian situation is an extreme case. "The Russian authorities came out and said, we will not take sell orders from foreign investors, which makes the market there uninvestable," he told me. "The question is, should international investors be in markets like this?" Nadig said. "Will international investors look at other markets and wonder if they also may not respect property rights?" Morningstar's Ben Johnson agrees. "Irrespective of whether it is investible, do I want to invest in certain markets at all, like China?" Johnson asked me. What should investors do? "The answer is, be diversified when investing in markets that are less liquid," Nadig told me. Finally, what will happen to those Russian stocks that will soon be valued at zero? They could begin trading again at some future date. Funds that are indexed to the new benchmarks without Russia in them could then liquidate their positions and exit Russia. But Nadig thinks there is a chance that there could be a re-nationalization of the Russian economy. "I think there is a good chance Russia will just nationalize all these companies," he said. "In that environment, the government will own the asset and whatever shares of Gazprom that might be public will become worthless."

Traders on the floor of the NYSE, Feb. 15, 2022.

Source: NYSE

On Friday morning, the NYSE halted trading in three Russian ETFs: Franklin FTSE Russia ETF (FLRU), iShares MSCI Russia ETF (ERUS) and Direxion Daily Russia Bull 2X Shares (RUSL). These halts were for "regulatory concern": They are not suspensions or delistings. The VanEck Russia ETF (RSX) trades on a separate exchange and as of 7:57 a.m. ET is still trading.

Several brief years ago, the growth of indexes and the corresponding expansion of exchange-traded funds allowed investors to put money into parts of the world that were largely inaccessible. Whole regions of the world and even individual countries suddenly became investable.

Now, it seems, that is starting to reverse.