Emerging markets have experienced an unexpected uplift this year, with the MSCI Emerging Markets index recording a 20% rise in sterling terms. This surge, however, appears to be less about broad-based economic growth across diverse emerging economies and more about the concentrated performance of a handful of technology giants heavily involved in the artificial intelligence (AI) sector.
Analysis reveals that two key markets, South Korea and Taiwan, despite often being considered more advanced than traditional emerging economies, remain classified within this group by MSCI due to specific currency restrictions. Within these markets, companies like Taiwan Semiconductor Manufacturing Company (TSMC), Samsung Electronics, and SK Hynix are significant beneficiaries of the global AI boom. These three companies alone constitute nearly 30% of the entire MSCI Emerging Markets index, with Taiwan and Korea together making up half of the index's weight.
The dominance of these tech firms means that the strong performance of the emerging markets index is largely a reflection of the AI trend, rather than a broad indicator of health across all developing economies. For instance, TSMC accounts for 55% of the MSCI Taiwan index, while Samsung Electronics and SK Hynix represent 60% of the MSCI Korea. This high concentration raises questions about the true diversification offered by many broad emerging market investment funds.
Traditionally, emerging markets are viewed as a diverse group, encompassing economies with vastly different drivers, such as China, India, and Brazil. However, the current trend suggests that the 'emerging market' label, in an investment context, is increasingly influenced by a narrow set of advanced technology companies. This poses a challenge for investors seeking genuine diversification across a wide range of developing economies.
While this concentration has proven highly beneficial for investors in broad emerging market funds during the AI surge, it also highlights a potential vulnerability. Should the AI boom decelerate or the US technology market experience a downturn, the highly correlated emerging market index would likely follow suit. This suggests that the current growth is deeply intertwined with the performance of the global tech sector, rather than being driven by the independent economic fundamentals of a diverse set of emerging nations.