How to pick the winners of the global supply chain crunch

‘Location is becoming just as important as manufacturing efficiency’

Supply shortages resulting from Covid-19 lockdowns, compounded by the Ukraine crisis, have challenged the idea of globalisation. In his annual chairman’s letter, Blackrock CEO Larry Fink said Russia’s aggression would push governments and companies to re-evaluate their dependencies on other countries.

But key parts of the global supply chain were being tested even before the pandemic, with trade disputes between China and the US. The pandemic itself exposed the risks of extended supply chains and has made agility, resilience, localisation and diversification an increasing area of focus for global companies.

The Russia/Ukraine conflict and the sanctions imposed by the United States and Europe will not only aggravate existing issues but broaden pressure on global commodities.

One of the biggest issues is Russia’s status as one of the largest global suppliers of oil and gas, in particular, because of Europe’s dependence on its pipeline gas. Russian and Ukrainian grain is critical to global food supplies, as the two countries account for 30% of global wheat exports and 78% of sunflower oil.

In addition, Russia is also one of the world’s largest producers of the commodities essential for the producing catalytic converters and semiconductor chips.

Major supply shortages

Graham Harrison, group managing director at Asset Risk Consultants, argues that supply shortages resulting from Covid-related lockdowns, followed by the Ukraine crisis, have challenged the idea of globalisation and ushered in a world in which autarchy is set to dominate investment thinking for years to come.

“As capital allocators, we are concentrating on the strategic implications of a rapid reversal of globalisation. We are examining our return and risk assumptions for equity and bond markets both at home and abroad. Over the coming months, we will likely be recommending changes in strategic benchmarks to reflect a radically changing geopolitical and economic landscape.

“Our latest sentiment survey highlights that investment managers are repositioning portfolios, albeit gradually. A year ago, the sentiment was more pronounced towards emerging markets whereas today, in common with the Far East and Europe, net sentiment is down by around 25%.”

Christopher Rossbach, chief investment officer at J Stern & Co, agrees that the conflict in Ukraine and the West’s response, vis-à-vis sanctions, will result in a significant realignment of global supply chains.

“It will accelerate the partial reversal of globalisation that we have seen as a result of the pandemic, which exposed that global supply chains are too long, too far, too complex and too vulnerable. We are already seeing nearshoring and diversification of suppliers.”

He adds: “We expect that US and European companies will be buying less from Russia and that Chinese, Indian and other companies will buy more. However, the demand and supply for commodities will not change. The global flows will be realigned, which will raise costs but will not ultimately disrupt the global economy.”

Gaining market share

In terms of winners and losers, Rossbach believes that market leaders that have strong balance sheets will weather near-term adversity.

“They are more likely to gain market share from weaker companies in uncertain times as they did in the last two years during the Covid pandemic – and to emerge from the current crisis even stronger than before.

“Companies like Eaton, a global technology leader in electrical systems, have proactively modified their supply chains by multi-sourcing, embracing digital logistics planning solutions and redesigning products. Much of our technology exposure has a strong focus on software and internet companies (Amazon, Alphabet, Meta) which do not have the same semiconductor issues associated with hardware companies.”

David Stevenson, fund manager at Amati Global Investors, believes there has been something of a check in the advance of globalisation but questions to what extent the reversal can feasibly go.

“Clearly things like Brexit, China trade tensions and now the Ukraine conflict have brought the idea of onshoring into greater focus. Location is becoming just as important as manufacturing efficiency.”

However, he adds: “Migration of Asian manufacturing back to US and Europe is being talked about a great deal but it is difficult to achieve, with higher labour rates in Western markets a major obstacle.”

Stevenson does see a more national rather than global emphasis in the energy sector. He believes supply pressures have forced countries to look at the benefits of onshoring for reliability of energy. “The transition from fossil fuels to renewables will take some time – you can’t just turn off oil and gas.”

He adds: “Many of the oil majors (who have performed strongly) are also big investors in renewables and providing the crucial infrastructure for cleaner energy. Nuclear energy companies look interesting too – we are likely to see further development of small-scale nuclear plants. Countries like Germany have come full circle – having initially been opposed to continued nuclear investment.”

Funds offering protection from supply chain crisis

Kate Marshall, lead investment analyst at Hargreaves Lansdown, picks out two funds in particular she believes offer a degree of protection in the current climate – Troy Trojan and Liontrust UK Growth.

“Troy Trojan fund invests in a mix of company shares, bonds, commodities, and cash. Sebastian Lyon, the fund’s manager, takes a long-term approach and looks for companies well placed to determine their own fortunes. He seeks to avoid businesses where too much of the risk is linked to external factors, such as those with excessive single-country exposures, or those whose profitability largely depends on commodity or energy prices that lie beyond their control.”

She adds: “When times do get tough for economies and markets, the fund’s investments in inflation-linked bonds, gold and cash could provide some ballast.”

The Liontrust UK Growth fund invests in quality UK companies of all sizes. “Anthony Cross and Julian Fosh, the fund’s managers, aim to find companies with an ‘economic advantage’ – a sustainable edge over the competition that will allow them to earn above-average profits for the long term,” Marshall says.

“The managers believe the hardest economic advantages to copy are intellectual property, such as patents and trademarks, strong distribution channels and significant repeat business. They also look for capital-light businesses and evidence of pricing power.”

Focus on companies that offer services over goods

Laith Khalaf, head of investment analysis at AJ Bell, says it very difficult to pick out funds that can beat supply chain issues because it’s not the sort of thing that managers will carry low or high exposure to as part of their investment philosophy.

Supply chain issues can affect a wide gamut of firms within the economy, and by extension within a fund portfolio. However, he thinks it is possible to pick out particular companies which might be more immune to global supply chain issues, and in this regard his thinking is similar to Rossbach.

“You can probably avoid the worst of any supply chain issues (though perhaps not entirely avoid them) by focusing on companies that offer services rather than goods and are therefore less affected by logistical problems.

“An example on the UK stock market might be Rightmove or Legal & General, or in the US the tech firms Alphabet and Meta.”

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