Iran risk erupts: Are emerging market trades, including TSMC, Samsung, and SK Hynix, which have made big profits this year, facing changes?
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As US and Israeli strikes against Iran caused stocks and currencies in some developing countries to fall, hedge funds that had previously made large purchases of emerging market stocks are now scrambling to reassess their positions.
On Monday, March 2, the MSCI broad emerging market stock index fell nearly 2%, with stocks in markets such as Turkey and India under pressure. JPMorgan’s emerging market currency index dropped 0.7%. Popular chip stocks like TSMC, Samsung, and SK Hynix also face revaluation risks.
This marks a reversal in the trend of emerging market stocks. As of last Friday’s close, emerging market stocks had risen 14% this year. Previously, the depreciation of the US dollar reduced the dollar debt and import costs of developing countries, while low oil prices provided a boost for nations heavily reliant on energy imports. However, US strikes on Iran may disrupt these trends. As investors seek safe-haven assets, the US dollar strengthens, Brent crude oil prices have surged by about 6%, and natural gas prices in Asia and Europe have also risen sharply.
Crowded Trades Face Risk
“I think emerging market trades are now facing huge risks,” an executive at a major macro hedge fund told the Financial Times.
“There is a lot of leverage in the system. (Funds betting on rising emerging market stocks and fixed income) have been a very easy one-way trade, and I think it will be challenged. This will impact the entire hedge fund sector,” the person added.
On Monday, India’s Nifty 50 index fell 1.2%, and Turkey’s BIST 100 index dropped 2.7%.
Goldman Sachs’s latest prime brokerage report, covering the week ending last Thursday, shows that hedge funds’ allocation to emerging market equities as a proportion of their total exposure "hovers near a five-year high". The report added that, in dollar terms, betting on emerging markets was one of the most favored trades that week, with stocks in South Korea and Taiwan particularly popular.
Duration of the Conflict Is Key
In recent months, concerns about AI disruption have led investors to diversify funds away from Wall Street stocks. Now, they say, the Iran conflict calls their plans into question.
Salman Ahmed, Global Head of Macro at Fidelity International, said that since emerging Asian economies are highly reliant on oil imports, “we are actively reviewing our exposure to emerging markets”. The asset manager had been optimistic about the asset class entering this year and built overweight positions.
Others stressed that only a prolonged conflict in Iran would lead to persistent sell-offs of emerging market indices. These indices also benefit from large inflows into chipmakers including TSMC, Samsung, and SK Hynix.
“If this turns into a protracted conflict, crowded emerging market trades will face risk. Everyone is piling into emerging markets. Most macro returns come from going long on emerging markets,” said a portfolio manager at a major macro fund.
The person went on to say that investors who have increased exposure to emerging markets in recent months “need the conflict to end as soon as possible.”
No Panic Selling Yet
Emerging market currencies, which usually fluctuate in sync with global risk assets, fell on Monday. The Hungarian forint, South African rand, and Brazilian real dropped 1% to 2% against the US dollar.
After central banks took measures to ease currency pressures, the Turkish lira remained flat against the dollar. Indonesia’s central bank also signaled readiness to defend the rupiah.
Vontobel portfolio manager Carlos de Sousa said that for oil importing countries like Turkey, “If prices stay at such high levels or higher for more than a few weeks, that will trigger inflation,” but the country has reserves to defend the lira.
“The fundamental drivers for good performance in emerging market fixed income still exist,” he added, noting that these countries have been reducing dependence on imports and foreign capital flows for years.
Over the past year, hedge funds have rushed back into the local currency debt markets of Egypt and Turkey, as both countries offer double-digit interest rates to support their weakened currencies. According to Citi Group, as the Iran conflict approached in recent weeks, some investors exited these trades and foreign-held Egyptian debt declined by $2 billion to $30 billion.
But some also bought protection measures to stay in the trades, betting the conflict will not last. One investor said: “Over the past few days, hedging has appeared in crowded positions in Turkey, Egypt, and some local markets,” including through credit default swaps and forward bets on currencies.
They added that so far there’s no sign of "serious capital outflows" from emerging market trades overall. “It hasn’t reached that kind of panic level yet. This is not the kind of liquidity event where credit lines are cut and funds flee to safe assets. Historically, that’s the truly painful event for emerging markets, and we’re not there yet.”
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