INVESTED: In Markets, in the Future, and in Society.

Russia: A Reminder We’re All Trading Pieces of Paper

Occasionally, we are reminded that the global stock and bond markets are made up of hundreds of millions of investors who are simply trading pieces of paper back and forth. Primary markets and the secondary capital markets where these pieces of paper are traded provide a tremendous value to society, acting as intermediaries by connecting savers with productive users of their capital, and allocating excess capital to participants who are looking for it. In normal times, these pieces of paper do have value attached to them, namely claims on corporate profits, or promises to repay borrowed funds with interest. But at the end of the day, they’re still just pieces of paper; if you chop back all the foliage, the value assigned to them is entirely dependent on whether someone is willing to buy them.
 
Russian paper has become confetti: the freezing of Russia’s foreign reserves, Moscow’s capital controls, and a ban on foreigners being allowed to sell securities locally have sent buyers running to the hills.
 
Bill Browder, who has decades of experience managing and investing money in Russia (and who’s lawyer Sergei Magnitsky was murdered in a Russian jail in 2009), reminds investors that “if you do business in countries without a rule of law, you could lose everything”. Those holding Russian stocks and bonds (such as major fund companies, ETF issuers, institutional investors, and governments) are currently holding worthless pieces of paper. This article by Institutional Investor shows what can happen when investors ignore corruption. The effect of a market becoming uninvestable ripples out into a vicious cycle, with the early movers taking huge discounts to exit their positions, and the laggards ending up being stuck with worthless paper. In this case, the major index providers would be defined as the laggards, as this week they began cutting Russian assets from their indices.
 
Systems such as stock and bond markets need strong institutions to thrive and function. We often take these institutions for granted; this is a good reminder that without them, our paper can quickly turn into confetti.