CONTRIBUTORS
Christy Tan
Senior investment Strategist
Franklin Templeton Institute
Lukasz Labedzki, CFA
Senior Analyst
Franklin Templeton Institute
Executive summary
At the start of 2026, we argued that emerging market (EM) equities and debt were compelling, not because volatility had disappeared, but because the biggest risk was oversimplification. Countries that shared an EM label no longer shared the same drivers, risks or opportunities.
Iran-related escalation briefly challenged that view. Correlations rose and markets defaulted to the familiar “EM is one trade” reflex. We see the episode as a demonstration of why the old EM framework no longer works: Index outcomes are a blend of very different country exposures, filtered through the prevailing global growth, inflation and liquidity regime.
History reinforces this point. Across prior oil-shock-style episodes, index-level EM equity and EM bond outcomes are not uniform during the shock or in the 12 months after it ends. The key variable is not “oil up = EM down,” but which EMs are energy importers vs. exporters, and how policy responds.
For institutional portfolios, we believe it may be best to approach an Iran-linked energy shock as a dispersion event. The transmission typically runs through the following:
- External balance: Net energy import burden vs. terms-of-trade tailwind (with parts of Asia most exposed to Middle East supply risk).
- Inflation and central bank reaction functions: Duration matters more than the initial spike.
- Fiscal buffers and subsidy regimes: Whether an external shock becomes a domestic-demand shock.
- Financing structure: Local market depth and credibility vs. reliance on US dollar (USD) funding.
- EM debt (institutional hinge variable): Whether the shock triggers a “dollar positive spiral” (as in 2022).
- Beyond crude: Liquefied natural gas (LNG), refined products/petrochemicals and critical inputs (e.g., fertilisers, helium, sulphur) can drive second-round shocks.
As we discuss in this paper, we think this is how to locate the gEMs: Build distinct return drivers across equities, local rates and hard-currency credit tilting to (1) structural compounders with pricing power, (2) reformers with credible policy and attractive real yields and (3) selective tactical beneficiaries/hedges.
Bottom line: Crisis has stress-tested the “end of EM” narrative—not disproven it
Questioning the “end of EM” narrative is understandable, because in the first phase of a geopolitical shock, the market temporarily trades EMs as one correlated bucket. Yet history shows there is no single EM oil shock template, especially in the 12 months following the shock. The composition of EMs today, depicting technology hubs, diversified manufacturers, reformers and still early stage frontiers, means that the real investment work is to map transmission channels and position for dispersion, not to retreat to the acronym. For EM investors, the single most important lesson of the last generation remains that active managers are best placed to cope with the frequent swings in fortune within the asset class. We think structural strengths and weaknesses will continue to drive the polarisation of returns, but we believe awareness of the geoeconomic pressures and constraints will be crucial, and should reward a knowledgeable, selective approach.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. No assurance can be given that any forecast, projection or prediction regarding economies or financial markets will be realized.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
To the extent the strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.
Currency management strategies could result in losses to the fund if currencies do not perform as expected.
Diversification does not guarantee a profit or protect against a loss.
Dividends may fluctuate and are not guaranteed, and a company may reduce or eliminate its dividend at any time.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Companies in the infrastructure industry may be subject to a variety of factors, including high interest costs, high degrees of leverage, effects of economic slowdowns, increased competition, and impact resulting from government and regulatory policies and practices.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact a portfolio. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.
Investment strategies incorporate the identification of thematic investment opportunities may be negatively impacted if the investment manager does not correctly identify such opportunities or if the theme develops in an unexpected manner.
WF: 9623360