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Q. Emerging markets are increasingly concentrated in a handful of Asian tech companies - should investors be warned about this risk?
A. You have put your finger on a very important issue.
Concentration risk has worried investors for a while now - but focus has been squarely on the US. The so-called ‘Magnificent Seven’ account for over a fifth of the MSCI World Index, a benchmark for developed markets, and about a third of the US market. This means returns are being driven by a handful of stocks that all occupy the same sector.
Emerging markets (EMs) face a similar dilemma, however. In fact, by some metrics, they are even more top-heavy than developed markets.
This is a fairly new phenomenon. In the early 2000s, the top 10 EM stocks accounted for less than 20% of the index and, more recently, their weighting has hovered around 25%.
Taiwan Semiconductor Manufacturing Company, or TSMC, has driven the change. The world’s biggest semiconductor foundry, TSMC makes the physical chips that power artificial intelligence. These chips are a miracle of modern engineering, made up of billions of ‘transistors’ - microscopic electrical switches that can be smaller than viruses or bacteria. TSMC represents a remarkable 14% of the MSCI EM index and about 1.8% of all global stocks, and manufactures most of the world’s high-end computer chips.
Two South Korean companies are also huge: Samsung and SK Hynix. These groups make memory chips, which enable AI to work more efficiently, and represent 8% and 7% of the EM index respectively. Their valuations have both recently crossed the trillion-dollar mark.
The question is: do investors need to be nervous about their explosive success?
There are a few things to consider. The first is a general point about diversification. Generally speaking, investing in a range of different countries, assets and sectors is a good way to manage risk. It means if one part of the market falls, your entire portfolio won’t suffer. When markets get very concentrated, diversification is harder to achieve, and you have to be more proactive about where you put your money
There are a couple of specific issues too. The first is geopolitical risk, which has increased in recent years. Such risks are notoriously difficult to predict, and many active fund managers prefer to focus on company fundamentals. However, Taiwan’s important role in Asian geopolitics is difficult to overlook.
The second thing to consider is AI. Do you believe the AI story justifies the amazing stock market gains we have seen, or are we in a bubble that is about to pop? Experts have very different views on this.
James Donald, fund manager of Lazard Emerging Markets, is nervous. “We’ve seen a market over the past six or seven weeks that has been extraordinarily difficult, and it’s all AI-related,” he told Fidelity. “In my opinion, it’s in a mania - and manias are very difficult to value or time,”
He pointed to extreme market movements we have seen in recent weeks. Shares in Lenovo, for example - a Hong Kong-listed PC maker which is also building data centres - have jumped by 65% in a single month.
Other investors are far more optimistic, however, arguing that AI has the power to transform the global economy and stressing the pivotal role that Asian tech companies play in the supply chain
Your stance on technology and Asian geopolitics will determine how you invest in emerging markets - and, indeed, more widely. If you are comfortable being very exposed to a handful of Asian tech stocks, a low cost tracker like iShares Core MSCI EM could be an appropriate choice. Some active funds also offer high levels of exposure to these remarkable mega-caps, including Schroder Oriental Income. At the end of April, TSMC and Samsung accounted for a quarter of this portfolio.
On the other hand, some actively managed funds try to steer clear of the market giants. Lazard Emerging Markets, for example, underweights Asian stocks and avoids Samsung entirely, instead prioritising Latin America.
You could also consider building your own emerging market exposure through region specific funds, thereby reducing your risk to some of these concerns. This could include funds focused on Latin America or country specific ETFs. Our Investment Finder can direct you toward some of the options.
Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Shares in investment trust are listed on the London Stock Exchange, and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Direct shareholdings should generally form part of a well-diversified portfolio of other investments. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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