With the Iran risk erupting, are emerging market transactions that have made huge profits this year including

# Long Yue

Source: Wall Street CN

U.S. and Israeli strikes on Iran have driven up oil prices and the U.S. dollar, pushing the MSCI Emerging Markets stock index down nearly 2% on Monday. The index includes high-profile stocks such as TSMC, Samsung, and SK Hynix. Hedge funds are reassessing their emerging market long positions, which stand near five-year highs. A prolonged conflict could trigger a sell‑off in crowded trades, although no panic‑driven large‑scale capital outflows have emerged so far.

As U.S. and Israeli attacks on Iran depressed stocks and currencies in some developing nations, hedge funds that had piled into emerging market equities are rushing to re‑evaluate their positions.

On Monday, March 2, the broad MSCI Emerging Markets stock index fell nearly 2%, with markets including Turkey and India under pressure. JPMorgan’s emerging markets currency index dropped 0.7%. High‑flying chip stocks TSMC, Samsung, and SK Hynix also face revaluation risks.

The move marks a sharp reversal for emerging market equities. As of last Friday’s close, emerging market stocks had risen 14% this year. Previously, a weaker U.S. dollar reduced dollar‑denominated debt and import costs for developing countries, while low oil prices provided a boost for nations heavily reliant on energy imports. However, the U.S. strikes on Iran threaten to break these trends. As investors sought safe‑haven assets, the dollar strengthened, Brent crude surged roughly 6%, and natural gas prices in Asia and Europe jumped sharply.

## Crowded Trades at Risk

“I think the emerging market trade is at enormous risk now,” a senior executive at a large macro hedge fund told the Financial Times.

“There’s a lot of leverage in the system. [Funds betting on rising emerging market equities and fixed income] have been a very easy one‑way trade, and I think it’s going to be massively challenged. That will have an impact across the entire hedge fund community,” the person added.

On Monday, India’s Nifty 50 fell 1.2%, while Turkey’s Bist 100 dropped 2.7%.

Goldman Sachs’ latest prime brokerage report, covering the week through last Thursday, showed hedge fund allocations to emerging market equities as a share of total exposure “hover near five‑year highs”. The report added that, in dollar terms, long emerging markets was one of the most favored trades that week, with South Korean and Taiwanese stocks particularly popular.

## Duration of Conflict Is Key

In recent months, investors have diversified away from Wall Street stocks amid fears over AI disruption. They say the Iran conflict has thrown their plans into doubt.

Salman Ahmed, global head of macro at Fidelity International, said the firm was “actively reviewing our emerging market exposure” given Asian emerging economies’ heavy dependence on oil imports. The asset manager entered the year bullish on the asset class and held overweight positions.

Others emphasized that only a prolonged conflict in Iran would lead to a sustained sell‑off in emerging market indices, which have also benefited from heavy inflows into chipmakers including TSMC, Samsung, and SK Hynix.

“If this becomes a protracted conflict, the crowded emerging market trade is at risk. Everyone piled into emerging markets. Most macro returns have come from being long emerging markets,” a portfolio manager at a large macro fund said.

Investors who added emerging market positions in recent months “need this conflict to end quickly”, the person continued.

## No Panic Selling Yet

Emerging market currencies, which typically move in lockstep with global risk assets, fell on Monday. The Hungarian forint, South African rand, and Brazilian real lost 1% to 2% against the dollar.

The Turkish lira was flat after the central bank acted to ease currency pressure. Bank Indonesia also signaled readiness to defend the rupiah.

Carlos de Sousa, portfolio manager at Vontobel, said for oil importers such as Turkey, “if prices stay at these levels or higher for more than a couple of weeks, that will stoke inflation”, but the country has reserves to defend the lira.

“The fundamental drivers for emerging market fixed income to perform well are still there,” he added, noting that countries had been reducing reliance on imports and foreign capital flows for years.

Over the past year, hedge funds have flooded back into local currency debt markets in Egypt and Turkey, as the countries offered double‑digit interest rates to support weak currencies. As the Iran conflict loomed in recent weeks, some investors exited those trades, with foreign holdings of Egyptian debt falling by $2 billion to $30 billion, according to Citigroup.

But others bought protection to stay in the trades, betting the conflict will not drag on. “We’ve seen hedging over the past few days on some of the more crowded positions in Turkey, Egypt, and local markets,” one investor said, including via credit default swaps and forward bets on currencies.

There were no signs of “serious outflows” across emerging market trades as yet, they added. “Things haven’t reached that level of panic. This isn’t the liquidity event where credit lines get pulled and money runs to safety. Historically, that’s the really painful event for emerging markets, and we’re not there yet.”

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