Emerging Markets

Emerging Markets: opportunity, concentration and the danger of mistaking momentum for diversification

Emerging Markets (EM) have enjoyed a powerful recent run, but the headline return tells only part of the story. Beneath the surface, the asset class has become unusually dependent on a very small group of AI-linked semiconductor companies, principally TSMC, Samsung Electronics and SK Hynix.

That does not mean emerging markets are unattractive. However, it does mean investors need to be clear about what they actually own.

For many years, emerging markets were viewed as a broad opportunity set: China, India, Taiwan, Korea, Brazil, Mexico, ASEAN, financials, commodities, domestic consumption, manufacturing growth and reform. Today, however, the benchmark has become much more concentrated. As of 30 June 2026, the MSCI Emerging Markets Index showed TSMC at 15.08%, Samsung Electronics at 8.16% and SK Hynix at 7.65%. Together, those three companies represented almost 31% of the index.

That is a significant change in the nature of the risk. A passive emerging markets allocation may still look diversified by country and by number of constituents, but the return experience is increasingly being driven by a narrow part of the Asian AI hardware supply chain.

This has also been clear in recent performance. Neuberger Berman described the 2026 emerging markets rally as a “ghost rally”, noting that while the index had risen by 22%, around 14 percentage points of that return came from just TSMC, Samsung and SK Hynix. In other words, the index return has looked strong, but much of that strength has come from a very small number of stocks.

This was also the central issue discussed in our recent meeting with Merlin Fidelis Emerging Markets managers Aaron Macksey and Sam Dyson. Aaron’s analysis was striking. He said the emerging markets index had risen by around 23% over the quarter, but that three stocks alone had contributed around 18 percentage points of that return. Adding a handful of smaller AI-related Taiwanese names, seven stocks had contributed roughly 90% of the quarterly index return. His conclusion was simple: without being neutral or overweight those names, it was almost mechanically impossible to keep pace with the benchmark.

That is not normal broad-market leadership. It is index concentration.

The same point was visible at the country level. Aaron noted that Korea (87%, USD) and Taiwan (49%, USD) entirely drove the index over the quarter, while much of the rest of emerging markets had done very little or fallen. He cited Hong Kong as down around 7.7%, India up around 9.7%, Indonesia down around 28%, Brazil down around 9% and Mexico up around 2%. His assessment was that the median emerging market stock had delivered a return close to zero for the quarter, meaning the index headline was not representative of the wider opportunity set.

This matters for portfolio construction. Investors may believe they are allocating to emerging markets because they want differentiated exposure from developed markets. If the Emerging Markets index returns are being driven by the same AI infrastructure theme that dominates parts of the US market, the diversification benefit is weaker than it appears for passive ETF investors in Emerging Markets. You need an active manager.

That concern is now becoming more widely recognised. BlackRock Investment Institute recently moved its stance on emerging market equities from a small overweight to neutral, while still identifying opportunities where AI infrastructure demand benefits regions such as Latin America. This is an important distinction. The issue is not that emerging markets should be avoided. The issue is that investors should avoid treating the benchmark as if it is still a clean expression of broad emerging market growth.

The recent increase in volatility reinforces that point. South Korea’s KOSPI fell almost 10% on 23 June, its steepest fall in more than three months, with Samsung and SK Hynix both falling more than 12% and triggering a market-wide trading halt. Reuters also reported that the two chipmakers now make up more than half of the KOSPI’s market value, and that regulators had warned about leveraged products and record margin debt.

That is why the volatility should not be dismissed as noise. It may not mark the top of the AI trade, but it does suggest market structure has become fragile. When a small group of very liquid, heavily owned, highly profitable companies dominates index returns, the unwind can be sharp. Liquidity cuts both ways. The same stocks that are easy to buy aggressively can also be easy to sell aggressively.

Aaron’s concern was not simply valuation in isolation. His argument was that the classic late-cycle warning signs are appearing together: peak earnings, peak profitability and peak valuation multiples. In the meeting, he highlighted that consensus expectations imply a dramatic increase in DRAM profitability for Micron, Samsung and SK Hynix between 2025 and 2028, while the market is already applying high multiples to those expected profits. The risk is that investors are paying today for a profit cycle that may already be very extended.

There is a fair counterargument. These are not speculative concept stocks with no revenues. TSMC, Samsung and SK Hynix are globally important businesses. The AI buildout is real. Demand for advanced memory, foundry capacity and semiconductor packaging has been intense. Reuters reported that SK Hynix is planning a 100 trillion won investment in new chip plants as part of a wider South Korean push to increase memory capacity, while also noting that demand from AI hyperscalers has caused shortages and pushed memory prices sharply higher.

So, the concern is not that the businesses are poor. The concern is that the market may now be extrapolating very favourable conditions too far into the future. Semiconductor cycles have always been prone to this. High prices lead to high margins; high margins encourage capacity; capacity eventually changes the balance between supply and demand. The precise timing is unknowable, but the cycle has not been abolished.

This is where Merlin Fidelis is positioned very differently from the benchmark. The fund is deliberately underweighting the AI semiconductor complex. In the meeting, Aaron described Merlin Fidelis as around 10% underweight TSMC, meaningfully underweight Samsung, with no exposure to SK Hynix. Overall, the portfolio was described as around 20% underweight the three major semiconductor names and around 34% underweight Korea and Taiwan combined.

That positioning has been painful over the June quarter relative to the index. The Merlin Fidelis May 2026 factsheet shows the Class F GBP Accumulating share class up 11.43% year to date versus the benchmark up 25.43%, despite strong long-term outperformance of the strategy. The same factsheet shows an active share of 80.5%, which confirms this is not a benchmark-hugging approach.

For MGTS Qualis Growth, that distinction matters. The Merlin Fidelis allocation is not designed to replicate MSCI Emerging Markets. It is designed to provide active, differentiated exposure to parts of emerging markets where the managers believe the risk/reward is more attractive: Hong Kong, China, ASEAN, Latin America and off-benchmark opportunities. Aaron described the index as “terribly contorted” and argued that the portfolio is positioned where valuation support is stronger and investor crowding is non-existent.

Our view is that the concerns are justified, but they should be framed correctly. This is not a reason to abandon emerging markets. It is a reason to question how emerging market exposure is built.

If an investor owns a passive EM tracker today, they are making a large active bet, whether they recognise it or not. They are making a bet that the AI semiconductor cycle continues, that earnings expectations are met, that capacity expansion does not undermine future pricing, and that leveraged ownership does not become a source of instability.

That may work for longer. Momentum can persist. Earnings may continue to surprise. AI capital expenditure may remain stronger for longer than sceptics expect. But the risk is no longer hidden. It is visible in index weights, visible in quarterly performance attribution, visible in daily volatility and visible in the gap between the benchmark and the median emerging market stock.

For MGTS Qualis Growth, the role of active management is not simply to chase what has already worked. It is to understand what is driving returns, assess whether those returns are repeatable, and avoid allowing a diversified portfolio to become overly dependent on one crowded theme.

Emerging Markets remain attractive, but not all EM exposure is equal. The opportunity today may not lie in buying more of the same winners. It may lie in owning the parts of the asset class that have been ignored while the index has become increasingly hostage to three companies.

This article is for information only and does not constitute investment advice or a personal recommendation. Capital is at risk, and the value of investments can fall as well as rise.