Tom Wilson, Head of Emerging Market Equities at Schroders
When geopolitical risk is elevated, where can investors add value?
Generally, investors have very limited edge in predicting geopolitical outcomes. Even the main protagonists may struggle to predict how the Iran conflict evolves. Hence, while we have a basic view on the motivations of the main protagonists, we believe our value-add lies in judging the relative exposure of countries and companies to the conflict, judging what is priced into different parts of the market, judging where we can take a view, and seeking to allocate and manage our risk appropriately.
A simple framework to assess economic sensitivity
We currently have a geopolitical shock with uncertain duration. Forecast risk is high, so there is more value in assessing relative sensitivity than creating point forecasts. We have a simple framework for assessing economic exposure to food and fuel inflation and disruption to energy supply. It is much more difficult to judge second-round effects such as broad-based supply chain disruption.
With regard to our framework, we firstly consider gross domestic product (GDP) per capita and the share of food and fuel in the consumer price index (CPI) basket. Food and energy are typically bigger constituents in the CPI baskets of less developed countries. Wealthy countries are also likely to be more able to bid out available cargo. Less developed countries will likely face higher physical deficit and more demand destruction. Then we consider whether a country is a net energy importer. A higher energy import bill will negatively impact external accounts and currency. If a country faces currency pressure and higher domestic inflation, there are likely consequences for monetary policy.
We also consider fiscal position: the extent to which a country could comfortably provide fiscal support to moderate pricing perhaps via subsidies or fuel duty relief. Finally, we consider energy mix (across oil, gas, coal, nuclear and renewables) and crude inventory. All of the above can feed into growth outcomes.
How does energy sensitivity differ for the “Big Four”
The bulk of emerging markets beta is concentrated in the four countries that constitute 80% of the EM index: China, Taiwan, Korea and India.
China is relatively well placed. It has a relatively defensive energy mix: coal is a high share of the total while half of its gas imports are piped. Meanwhile, China has significant strategic reserves.
India sits at the opposite end of the spectrum. India is a major energy importer. A higher energy bill pressures external accounts and the currency. India’s crude reserves are relatively low. India is also less developed. Food and fuel are relatively high in its CPI basket. There is likely to be some modest fiscal impact as the government seeks to mitigate the inflationary impact of higher energy and fertilizer prices. All of this is likely to feed into pressure on growth.
Taiwan and Korea sit in the middle. They are energy importers, but they are also wealthier economies with stronger external buffers. Thanks to the tech cycle, Taiwan’s current account surplus is expected to exceed 20% of GDP in 2026, which dwarfs any increase in the energy import bill. It has very high economic resilience and while at some point there may be a disruption to tech inputs, we expect AI-related capex to remain very robust, so supply disruption would only tighten the market further. Korea also has a very material current account surplus thanks to the current tech cycle.
Beyond the Big Four: Applying the same lens across regions
Among the Association of Southeast Asian Nations (ASEAN), exposure is generally higher. Indonesia can benefit as a coal exporter, but otherwise is exposed, as are Thailand and Vietnam. In Europe, the Middle East and Africa (EMEA), Turkey and South Africa are more exposed.
Meanwhile, Latin American markets fare better: Brazil is a net energy exporter, while Mexico’s energy balance is neutral and the majority of its gas is piped from the US.
US dollar depreciation was a driver of emerging markets in 2025, has our view changed?
The US dollar is an important transmission channel for emerging markets. In the near term, the Iran conflict supports the dollar, most notably given US energy self-sufficiency. Over the medium term, we continue to see potential for dollar depreciation, due to a reduced appetite for external investors to fund elevated US twin deficits (fiscal and current account), combined with a high net international investment position. The US dollar is inversely correlated with emerging market equity relative performance. Dollar depreciation eases financial conditions in emerging markets: EM FX appreciation is typically the other side of US dollar depreciation, which can benefit inflation via currency passthrough, facilitating monetary easing, and supporting US dollar nominal growth.
How to allocate risk when geopolitical risk is elevated?
Investors should allocate risk where they have conviction. We currently have a geopolitical shock with uncertain duration. This increases forecast risk.
Our assessment of relative economic sensitivity feeds into our view on country allocation. We don’t favor positioning aggressively in exposed parts of the market. India would benefit from normalization, but valuations remain unattractive and the recovery in growth being seen pre-conflict has likely stalled.
We favor allocating risk where we think investors can have conviction: in tech hardware, where we are seeing the strong emergence of commercial use cases for AI which supports our view on AI capex; in areas that have relative resilience against ongoing disruption; and where valuations provide sufficient margin of safety. Themes that have been reinforced include defense and electrification, driven by expectations of persistently higher geopolitical risk and considerations around energy security. We also believe gold will be an ongoing beneficiary of investor flow, given concerns regarding lack of fiscal discipline and fiat currency debasement, combined with ongoing central bank reserve diversification.
What is our framework for thinking about the Iran conflict?
A brief view on geopolitics follows. Please treat this with care, we would not pretend to understand the breadth or balance of motivations of geopolitical protagonists. Our baseline view is that sustained closure of the Strait of Hormuz is so damaging to global macro and markets, that there has to be resolution. This resolution may need to be forced by escalating economic and market stress. The key question relates to timing, while belief in the sustainability of any normalization is also highly relevant.
On the basis of recent behavior and events, it appears that neither the US nor Iran seeks a resumption of hot conflict, the ceasefire has held despite intermittent military action. It is likely that the US doesn’t want the global economic and domestic political damage of ongoing closure of the Strait, while the Iranians want regime survival and to avoid further attacks on their economy and leadership. There is the potential for a deal in principle with, at its core, some compromise on the suspension of nuclear enrichment and the management of existing enriched uranium in return for the release of sanctioned funds and future sanctions relief. This deal may reflect elements of the original Joint Comprehensive Plan of Action (JCPOA). Any deal will need to accommodate a material and mutual lack of trust.
We believe that Iran will see itself as having leverage via its closure of the Strait and while its own crude exports are now constrained by US blockade, it is willing to wait longer than the US on reopening the Strait. The longer the Strait is closed, the greater and more visible the economic damage and markets don’t appear to be pricing a sustained closure.
As the dominant customer for Iranian crude, China may seek to facilitate a deal, given its own interest in avoiding global economic stress that would come via an extended closure of the Strait. In the absence of a deal, there may still be an agreement to permit transit through the Strait, perhaps involving tolling, though this may not lead to full normalization and would sustain risk premia due to concerns about its sustainability.
Near- and long-term scenarios for energy supply and demand
We believe that near-term energy demand will be supported for some time post conflict by inventories being rebuilt to higher levels. But on a longer horizon, supply may be lifted by UAE’s departure from OPEC and sanctions relief that would enable Iran to grow its production and increase crude exports.
As it stands, a combination of energy switching, a pivot from strategic reserve build to reserve drawdown, the drawdown of commercial inventories, and demand destruction has moderated the near-term impact on energy markets and limited price increases. At some point, commercial inventory drawdown will run out of room, potentially in July. Fertilizer disruption and higher input costs are expected to lift food inflation with a lag. Markets may look through near-term economic stress and focus on a deal and normalization, but inflation could surprise to the upside, and we could see a more severe near-term energy supply shock.
ENDS
