The ongoing conflict in the Middle East has introduced a layer of complexity that is difficult to quantify in the immediate term. We are currently seeing a classic "risk-off" environment, where the initial positive outlook for the year has been clouded by geopolitical friction.
The Current Landscape: A Period of Heightened Risk
The effective closure of the Strait of Hormuz has created a significant global energy impulse, reviving inflation concerns just as the post-pandemic cycle appeared to be normalizing. This has led to a predictable "flight to safety," with capital retreating into the US Dollar and Treasuries. While gold has seen a correction recently, this appears to be tactical profit-taking following a historic rally, rather than a shift in its status as a long-term hedge. For Emerging and Frontier Markets (EM/FM) investors, this combination of a stronger USD and higher discount rates creates a challenging short-term hurdle for valuations.
Tactical Positioning: Active Risk Management
We are monitoring the situation hourly and adjusting the portfolio to reflect the shifting risk-reward landscape. Specifically, in the Evli Emerging Frontier fund we have taken steps to reduce our direct exposure to the Middle East, taking some risk off the table where the proximity to the conflict creates unnecessary volatility. Simultaneously, we are reallocating that capital into other Emerging and Frontier regions—such as parts of Southeast Asia and Latin America—where the short-to-medium term outlook remains more insulated from this specific conflict. By pivoting toward markets with stronger idiosyncratic drivers and less "geopolitical beta," we aim to preserve the fund’s upside potential while dampening the impact of the current regional instability.
The Case for Resilience: Why Long-Term Drivers Remain Intact
Despite the headlines, the fundamental investment case for our universe remains not only intact but, in many ways, reinforced by these events.
- Structural Value and Growth Asymmetry: Emerging and Frontier Markets valuations remain exceptionally attractive, particularly when compared to Developed Markets (DM) that are priced for perfection. The growth engine of our universe—driven by demographics, urbanization, and rapid digitalization—is not tethered to a single geopolitical event.
- A "Hardened" Universe: The past five years have served as a perpetual stress test for emerging economies. From pandemic disruptions to historic inflation, these markets have developed a level of institutional and fiscal resilience that is often underestimated. Many EM/FM central banks were ahead of the curve in tightening policy, leaving them better positioned to handle this new inflation impulse than their DM counterparts.
- The Operational "Alpha" of Quality Companies: High-quality companies in these regions are "friction specialists." They grow not because of the environment, but because they have the scale to bypass the hurdles that kill smaller competitors. While the market index may show volatility, the actual operations of our holdings remain robust.
- Decoupling and Resilient Fundamentals: Current oil prices, while elevated, are within a range these economies have navigated before. Contrary to investor worries, most emerging economies have emerged from the crises of the last few years stronger and more self-reliant. We believe the current market is experiencing a sentiment-driven disconnect, whereas the underlying corporate health of our holdings remains stable.
Conclusion
We are undoubtedly moving through a period of increased risk aversion, which historically creates a "valuation gap" in emerging assets. However, we view this as an opportunity for active selection. By tactically managing our regional exposures while staying anchored in high-growth, high-quality companies, we are positioned to navigate the volatility and capture the recovery as the situation stabilizes.
