Defense and Industrials: Strategic Positioning for High-Conviction Growth in Emerging Markets

The defense and industrials sector in emerging markets has emerged as a compelling arena for high-conviction growth investing, driven by a confluence of geopolitical imperatives, technological innovation, and structural reforms in developing economies. As global defense budgets swell and industrial policies prioritize self-reliance, investors are increasingly turning their attention to regions where strategic positioning can yield outsized returns. However, navigating this landscape requires a nuanced understanding of both macroeconomic tailwinds and sector-specific risks.

A Sector on the Rise

Between 2023 and 2025, the aerospace and defense (A&D) sector has demonstrated robust growth, with the top 100 global A&D companies reporting $922 billion in revenue in 2024 alone. Defense budgets have expanded by 9% year-over-year, spurred by NATO's pledge to increase spending to 5% of GDP within a decade and the U.S. Department of Defense's aggressive modernization agenda. In emerging markets, this trend is amplified by nations seeking to reduce reliance on foreign suppliers and build indigenous capabilities. For instance, South Korea's defense exports to the Middle East-driven by partnerships with Saudi Arabia and the UAE-highlight how industrial policy and technology transfer agreements can catalyze growth.

Technological innovation, particularly in artificial intelligence (AI) and autonomous systems, is reshaping the sector. The U.S. Air Force's adoption of AI for real-time targeting and decision-making underscores the transformative potential of these technologies. Similarly, emerging markets are investing in AI infrastructure and electrification, with firms like Turkey's Roketsan and Singapore's ST Engineering integrating advanced analytics into their product lines.

Strategic Positioning: Balancing Long-Term Vision and Short-Term Volatility

Constructing a high-conviction portfolio in defense and industrials requires a dual focus on long-term strategic positioning and short-term risk mitigation. Emerging market governments are increasingly leveraging industrial policies to foster domestic innovation. For example, the UAE's Tawazun program and Saudi Vision 2030 emphasize localizing defense production, creating opportunities for firms that can align with these agendas. Investors must assess whether companies are merely assembling imported components or developing proprietary technologies-a distinction that separates transient beneficiaries from enduring winners.

Regional case studies illustrate this dynamic. In Southeast Asia, Indonesia's defense acquisition strategy has been constrained by low spending and reliance on second-hand equipment. However, its recent investments in port infrastructure and semiconductor manufacturing suggest a pivot toward industrial self-sufficiency. Conversely, Mexico's robust infrastructure development and AI readiness index position it as a potential hub for high-tech industrials, despite broader foreign direct investment (FDI) declines in 2024.

Portfolio Construction: Diversification and Resilience

Portfolio construction in this sector demands a disciplined approach to diversification. The engineering and construction industry, a critical enabler of defense infrastructure, faces headwinds such as elevated tariffs and supply chain disruptions. Firms that adopt resilient procurement strategies-such as strategic stockpiling and supplier diversification-are better positioned to weather volatility. For instance, Deloitte's 2026 outlook highlights the growing importance of predictive maintenance and digital tools in the aftermarket services segment, which offers a more stable revenue stream compared to capital-intensive manufacturing.

Risk-adjusted positioning also requires attention to geopolitical and regulatory uncertainties. The surge in securities fraud lawsuits in China and the U.S. return to protectionist policies under the Trump administration underscore the need for geographic diversification. Investors should prioritize markets with transparent governance frameworks and stable policy environments, such as Singapore and South Korea, while hedging against overexposure to regions with regulatory opacity.

High-Conviction Case Studies: Lessons from the Field

High-conviction growth strategies are best exemplified by firms that align with structural trends. In the Middle East, the UAE's phase-out of Mirage 2000-9s in favor of Rafale jets reflects a strategic shift toward next-generation capabilities. Similarly, South Korea's success in the Gulf defense market-rooted in its willingness to transfer technology and offer competitive pricing-demonstrates the value of flexible industrial policies.

Emerging market infrastructure projects also offer compelling opportunities. Mexico's expansion of port capacities in Manzanillo and its focus on local currency bonds illustrate how public-private partnerships can drive industrial growth. Meanwhile, Indonesia's maritime security challenges have spurred demand for advanced surveillance systems, creating a niche for firms specializing in AI-driven analytics.

Navigating the Risks

Despite the sector's promise, investors must remain vigilant about systemic risks. Global FDI declined by 11% in 2024, reaching $1.5 trillion, signaling a broader slowdown in capital flows that could impact emerging market projects. Additionally, infrastructure financing gaps in Asia and geopolitical tensions-such as those in the South China Sea-pose persistent threats to long-term stability. To mitigate these risks, portfolios should emphasize companies with strong cash generation and diversified revenue streams. For example, firms engaged in both defense and commercial MRO services, such as those highlighted in Deloitte's 2026 outlook, offer resilience against sector-specific downturns. Furthermore, integrating alternative assets-such as private equity stakes in emerging market defense firms-can enhance risk-adjusted returns.

Conclusion

The defense and industrials sector in emerging markets represents a unique intersection of geopolitical necessity and technological innovation. For investors with a high-conviction approach, the key lies in identifying companies and regions that are not merely riding the wave of current trends but are actively reshaping the landscape through strategic industrial policies and technological integration. By balancing long-term positioning with disciplined risk management, investors can capitalize on the sector's growth potential while navigating its inherent volatility.