Lazard flags emerging market investment dangers

Emerging markets have changed. A small group of technology leaders now control most of the benchmarks, requiring investors to adjust their strategies.

Index concentration reaches historic highs

Three firms—TSMC, Samsung Electronics, and SK Hynix—now represent about 40% of the MSCI Emerging Markets Index. The change happened quickly. In October 2020, China held 43-44% of the index. Its share has since fallen below Taiwan’s, and earlier this year, the country’s entire weighting was smaller than TSMC’s alone.

Monika Shrestha, who manages Lazard’s Emerging Markets Equity Fund, described the shift as remarkable. She noted that passive funds tracking the index now carry heavy exposure to a narrow set of stocks, raising risk. “Diversification and an active approach matter more than ever,” she stated.

The fund holds around 80 stocks, intentionally avoiding the index’s growing concentration. While technology remains its largest sector at 25%, Lazard has reduced its weight compared to the benchmark. It has cut positions in AI-driven stocks, prioritizing companies with strong, stable returns on equity at lower valuations.

Performance outpaces the benchmark—but risks remain

The approach has yielded strong results. Over the 12 months ending July 31, the fund achieved annualized gains of 35%, exceeding the MSCI Emerging Markets Index by 10 percentage points. Stock selections in tech—including TSMC, SK Hynix, MediaTek, and Lenovo—drove much of the performance, benefiting from demand for advanced semiconductors and AI-related hardware.

Despite its tech focus, the fund is slightly overweight China relative to the index. Taiwan, however, is underweight by 12% due to TSMC’s outsized influence. The strategy also favors financials and energy while increasing exposure to consumer and communication sectors.

Shrestha’s team is expanding its search beyond East Asia. “We’re identifying well-managed companies in Brazil, Indonesia, Mexico, and South Africa that deliver high, stable returns,” she explained. Investors have largely ignored these markets, making valuations appealing.

The fund includes Brazilian financials, energy, and healthcare, such as an insurance brokerage and a hospital chain. High domestic interest rates have created barriers, protecting established players.

While technology and East Asia anchor the portfolio, the concentration in benchmarks means emerging markets can no longer be treated as a single entity.

“This is where stock pickers prove their worth,” Shrestha said.

The fund balances exposure to dominant tech names with selective bets in overlooked regions. This approach mirrors a broader tension in emerging markets. As benchmarks favor a few winners, the argument for active management strengthens.

Shrestha acknowledged the difficulties. “The market demands more careful analysis than ever,” she said. Investors must decide whether the potential rewards justify the effort.