EMs keep their edge

DESPITE recent turmoil in emerging markets (EMs) triggered by geopolitical shocks in the Middle East, institutional investors remain confident in their long-term potential.

Many see the current sell-off as a temporary pause rather than a reason to abandon EMs, even as short-term volatility rattles markets.

Portfolio managers at major asset management firms, including Pacific Investment Management Co, Barings LLC and T Rowe Price Group Inc, tell Bloomberg they are holding off on wholesale repositioning.

Instead, most are selectively seeking opportunities, confident that the structural drivers behind EM performance will reassert themselves once the geopolitical fog lifts.

Many investors point to three enduring themes underpinning interest in EM: diversification away from US assets, attractive relative valuations, and comparatively robust economic growth.

Fund flows in recent sessions have suggested that some investors are using the price weakness as a chance to increase exposure.

“We’re waiting for more clarity,” Nick Eisinger, the head of EM sovereign credit strategy at JPMorgan Asset Management, tells Bloomberg.

“We like the fundamental story across a lot of EMs, but unfortunately the fundamental stories don’t really count for very much right now, so we need this shot to pass,” he adds.

That remark neatly captures the current sentiment: positive about fundamentals, cautious on near‑term catalysts.

The hit to EMs has come amid escalating conflict in the Middle East and a surge in oil prices, raising fresh concerns about growth in economies that must import most of their energy needs.

At the same time, the US dollar has strengthened as investors revert to safe‑haven trades, tightening financial conditions and unnerving international investors in EM assets.

Indeed, JPMorgan Chase & Co downgraded its recommendations on EM assets three times in recent weeks, cutting “bullish” calls to “market-weight” in foreign exchange and local rates, and tactically moving to “underweight” positions on sovereign and corporate dollar bonds.

This cautious shift reflects heightened uncertainty in markets that are still sensitive to shifts in global risk appetite.

Temporary pain

Bill Campbell, a portfolio manager at DoubleLine Group LP, tells Bloomberg he does not see recent events as a “fundamental” turning point for EMs.

“I’m not in the camp that this fundamentally changes everything, that it’s time to close out all EMs,” he says.

Instead, he regards geopolitical turmoil as an exogenous shock – one that should remain contained and, in time, pass.

“In that case, it doesn’t change, a priori, the conditions of a supportive global growth backdrop, EM‑developed market convergence, and the worries about fiscal and term premium in developed markets,” Campbell notes.

He adds that valuations in EMs remain attractive and, with some crowded trades unwinding, there may be cleaner positioning that could reward investors if clarity on geopolitical developments emerges.

“If we get some clarity or some more line of sight on the Iran situation, this could be a fantastic spot to re‑engage in EM currencies and EM local rates,” he says.

Pramol Dhawan, head of EMs portfolio management at Pimco, echoes the idea that the current EM cycle is more durable than past rallies, including the one seen in 2008.

“We are currently seeing one of the key risks play out in real time, that of geopolitical friction,” Dhawan says.

He points to three pillars he believes will sustain EMs over the long term: sovereign fiscal credibility, evidence that central banks have anchored inflation expectations, and continued rotation by global investors who remain “underweight” on EMs relative to fundamentals.

Powerful combination

For Ghadir Cooper, global head of equities at Barings, the impact of geopolitical risk extends beyond EMs and into global markets generally.

“High oil prices, if persistent, will have a detrimental effect on all energy importing countries,” she tells Bloomberg.

Cooper believes there is a “powerful combination supporting EMs going forward – attractive valuations and it is what we believe a very under‑owned asset class, not represented enough in portfolios”.

She argues that EM policymakers have generally shown greater fiscal prudence than peers in developed markets and highlighted a growing diversification case out of US assets into international and EMs.

From a fixed‑income perspective, views are similarly nuanced.

Eric Fine, head of EM active debt at VanEck Associates, noted that while risks have increased, especially near the Gulf region, there remain identifiable opportunities outside conflict proximity.

“Gulf bond spreads are largely unchanged, yet risks have clearly risen... so reducing that exposure is pretty straightforward as there are other alternatives without proximity to the conflict,” he says.

Fine adds that EM local currency assets have become cheaper – prompting VanEck to increase exposure after previously trimming positions when markets felt “too frothy”.

He points to regions such as Latin America and sub‑Saharan Africa as beneficiaries of commodity price dynamics, while noting that Asia may face economic headwinds despite strong external accounts and policy frameworks, anchored in part by an appreciating Chinese yuan.

“The only metric that matters for now is conflict duration,” Fine says, warning that rising estimates of prolonged conflict could shift markets toward pricing in higher global recession odds.

But he also notes that persistent high commodity prices mean that EM commodity exporters aren’t obviously vulnerable in such an outcome.

Samy Muaddi, head of EMs fixed income at T Rowe, summed up the resilient underpinnings that many investors see in EMs today.

“EM foundation is quite good right now, so it’ll likely survive the latest bout of risk aversion,” he says.

However, Muaddi acknowledges that the combination of higher oil prices and looser US fiscal policy could “contaminate the rates outlook”, emphasising that shifts in core rates, volatility or equity risk naturally spill over into EMs.

Muaddi highlights a rotation within credit markets toward higher‑quality, higher‑liquidity names that began last year and has held up during the recent sell-off.

In local markets, he says, the preference is for countries without imminent election risks and where real interest rates remain elevated – citing examples such as Mexico, Romania and Turkey.

“Latin America is more immune from a financial conditions perspective and should benefit from portfolio rotations,” he adds.

While short‑term volatility and geopolitical uncertainty are front of mind, the overarching message from many investors surveyed by Bloomberg is that EMs still offer compelling reasons for engagement – especially for those willing to look beyond the current headline risks. — Bloomberg