Emerging markets have changed – is your portfolio more concentrated than you think?

Emerging markets may be more concentrated than many investors realise.

If you invest in Asian and emerging markets and haven't looked under the bonnet of your portfolio recently, you might be surprised by what you find.

Much has been written about the dominance of a handful of technology giants in the US market. But less attention has been paid to a similar trend taking place in Asia and emerging markets, where a small number of semiconductor companies have become increasingly influential.

As a result, investors previously seeking exposure to fast-growing economies, rising consumer wealth and favourable demographics may now have more exposure to the artificial intelligence (AI) boom than they first thought.

That's not necessarily a bad thing.

In fact, it’s been a major driver of performance. But it does highlight how much the emerging markets landscape has changed and why it's important for investors to understand exactly what they own.

Just a year ago, China and India accounted for nearly half of the emerging stock market. Today, it’s closer to 30% and instead Taiwan and South Korea together represent around half of the MSCI Emerging Markets Index. This reflects the growing importance of a handful of technology and semiconductor companies.

This article is for information only and not personal financial advice. Investing can help your money grow, but the value of investments can rise and fall, so you could get back less than you put in. Investing is for the long term, typically 5 years or more. If you’re not sure what’s right for you, a financial adviser can help.

From economic growth to AI growth

For years, the case for investing in emerging markets centred on themes like economic development, increasing urbanisation, rising disposable incomes and favourable demographics.

Investors often looked to countries like China and India as the primary beneficiaries of those trends. The prospect of millions of people joining the middle class and increasing their spending power formed a key part of the investment case.

Those opportunities still exist. But they’re not currently the dominant force driving market returns.

Emerging stock markets are becoming increasingly influenced by businesses supplying the hardware for the AI revolution. This includes Taiwan Semiconductor Manufacturing Company (TSMC), Samsung Electronics and SK Hynix – the three of which account for over 30% of the MSCI Emerging Markets index. Overall, technology now makes up 45% of the index.

In other words, investors who believe that they own a portfolio linked primarily to traditional emerging economic growth may in fact have more exposure to the global technology sector.

Why Taiwan and South Korea have become so important

The answer lies in the semiconductor industry.

TSMC, based in Taiwan, manufactures many of the world's most advanced chips. Its customers include some of the biggest names in global technology, and it plays a key part in the AI supply chain. South Korean companies Samsung Electronics and SK Hynix are key suppliers of memory chips and other components vital to AI infrastructure.

As demand for AI-related technology has surged, so have the share prices of these businesses. Their growing market values have increased their weights within major stock markets.

Taiwan’s rise is also reflected in the fact that it recently overtook India to become the world's fifth largest market. It’s even more surprising given India's population exceeds 1.4 billion people while Taiwan's population is only around 23 million. And although India is the sixth largest economy in the world, Taiwan is only the 22^nd.

Taiwan's growing influence reflects the global importance of companies like TSMC rather than the size of the Taiwanese economy itself. As investors around the world have poured money into businesses linked to the AI boom, Taiwan's stock market has become one of the biggest beneficiaries.

Has the market forgotten China and India?

Against the backdrop of AI excitement, China and India have been left somewhat in the shadows.

China continues to face challenges from slower economic growth, to weakness in its property sector and ongoing geopolitical tensions. As a result, investor sentiment remains subdued despite valuations appearing significantly lower than some other major markets.

In India, we think the long-term investment case remains attractive, supported by favourable demographics, rising incomes and a growing middle class.

But Indian markets contain fewer companies directly benefiting from the AI hardware boom. Financial services, consumer businesses and traditional IT services remain more prominent. As capital has flowed towards semiconductor and AI beneficiaries, India has struggled to keep pace.

That said, markets that have lagged offer diversification benefits and potentially more attractive valuations than the areas that have attracted the most enthusiasm.

Why fund structure matters

The level of concentration that investors experience can also depend on the type of fund that they hold.

An index fund, for example, is designed to track its benchmark. If a company becomes a larger part of that index, then it also becomes a larger part of the fund. So, TSMC now makes up 19% of some Asian index funds.

That can make index funds look quite different from many actively managed funds, which aim to beat the performance of a benchmark. Active funds can invest only up to 10% in a single company. Those limits are sensible guardrails where managers are making active decisions.

This is not about one approach being better than the other. It simply means that investors should understand that an Asian index fund with large positions in some companies may provide a different type of exposure from an active fund.

However, investing in funds is not right for everyone. Investors should invest only if the fund's objectives are aligned with their own and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest and make sure that any new investment forms part of a long-term diversified portfolio.