When Tech Dominates EM, Passive Is No Longer Neutral

Emerging markets are outperforming again. But many investors buying passive EM exposure may not be getting the broad macro asset class they think they own.

The MSCI EM Index has become unusually concentrated in a small group of North Asia semiconductor and hardware companies tied to the global AI investment cycle. As a result, passive EM exposure today is less neutral than it appears: it embeds a large, implicit bet on a highly concentrated technology theme.

While we remain constructive on emerging markets, as discussed in our earlier blog Shifting Tides in Global Markets: The Reemergence of International Investing, this shift underscores a key point: how investors access EM exposure, whether through active or passive strategies, matters more today than it has in years.

In this blog, we examine the trade-offs between these approaches and argue that, at this stage of the cycle, active portfolios may offer a more effective way to capture emerging market returns.

From 2015 to 2024, MSCI EM lagged the S&P 500 by roughly nine percentage points per year. That trend has reversed over the past two years, with the index up 15% year to date as of April 22, 2026, following a 34% gain in 2025. At face value, this should be a windfall for EM investors. In practice, however, the rally has been driven by a small group of stocks—making implementation critical.

Over the 12 months from April 22, 2025 to April 22, 2026, the EM index has returned 52.7%, but a disproportionate share of those gains has come from just two countries—Taiwan (39%) and South Korea (33%)—out of the 24 in the index. Within those markets, returns have been even more dominated by a handful of names, with one stock in Taiwan and two in South Korea accounting for the majority of gains (Chart 1).

By construction, this reflects the index’s growing exposure to the market’s dominant theme: beneficiaries of the global AI investment cycle, a theme highlighted in a recent Financial Times article A retro rally is coming from e-merging markets.

Chart 1: Index Return Contribution by Key Components, Based on MSCI Indices

While index distortion in US equities is widely discussed (see Market Concentration and the case for Deliberate Exposure) a similar dynamic in emerging markets remains underappreciated. For example, the largest stock in the MSCI EM Index (TSMC) now accounts for nearly 15% of the index, compared with less than 10% for Nvidia in the MSCI USA Index.

This pattern extends beyond a single name: the top three stocks together represent almost 25% of the EM index, exceeding the equivalent concentration in US benchmarks (Chart 2). Notably, all three are semiconductor or hardware companies, reinforcing the index’s growing dependence on a small segment of the market. Beyond concentration at the stock and country level, the index’s evolving composition also raises a broader question about what EM exposure represents today.

Chart 2: Weight of the Largest Stocks in the Respective MSCI Indices (Expressed as %)

For decades, emerging markets traded as a macro asset class, a leveraged expression of the dollar cycle, domestic growth, and external balances (we discuss this further in 10 Rules of Country Selection in Emerging Markets). Today, the EM equity index looks very different. It has become increasingly dominated by a few mega-cap technology companies whose fortunes are tied more closely to AI investment and global supply chains than to traditional EM macro drivers.

Yet many global allocators still approach EM as a macro asset class tied to currencies, domestic growth, and external balances. This creates a growing disconnect: in its current form, the EM index increasingly functions as an indirect play on global technology investment and US-led AI capital expenditure.

As a result, investors seeking diversification away from US equities may not achieve the intended outcome through passive EM exposure alone. Furthermore, research by Arslanalp et al. (IMF, 2020) highlights that benchmark-driven allocations can amplify the role of external factors at the expense of domestic fundamentals, increasing the risk of flows that are disconnected from local economic conditions.

For allocators aiming to express macro views, a more targeted approach may be required. Active strategies, in this context, offer the flexibility to align portfolios with underlying macro drivers rather than with the backward-looking composition of the index.

This concentration also leaves the index highly dependent on the semiconductor cycle. Passive or benchmark-oriented investors fully participate in the upside of the AI-driven capex cycle, but they are equally exposed to its cyclicality.

By design, such approaches offer limited flexibility to trim positions as valuations rise, cap exposure to individual names, or reallocate toward other emerging market opportunities. If the global AI investment cycle slows or becomes more volatile, EM index returns are likely to reflect that volatility more directly (Chart 3).

Chart 3: Rising Semiconductor Weight in MSCI EM Index (Expressed as %)

Markets evolve in cycles, and passive tends to arrive late. EM history is a sequence of shifting cycles such as commodity booms, China‑led credit expansions, deregulation waves, and now the AI hardware cycle. By design, indices end up most heavily exposed to yesterday’s winners just as their risk–reward often starts to deteriorate.

Active investors, by contrast, can re‑allocate as policy, credit, and earnings cycles evolve, positioning ahead of the next phase rather than anchoring on past market cap.

What began as a macro asset class tied to the dollar cycle, domestic growth, and external balances is now an index dominated by semiconductors and hardware. That shift has delivered spectacular returns for a handful of names, but it has left the average EM stock trailing the MSCI EM Index by roughly 7–10 percentage points per year in recent years—a marked departure from the long-term pattern. Since the end of 2022, the MSCI EM Index has returned approximately 22% annually, compared with about 12% for the median stock (Chart 4).

Chart 4: Annualized USD Return for Emerging Market Indices

For allocators who continue to use EM to express macro views and access a broad opportunity set, a tech-heavy benchmark may be an imperfect implementation tool. At this stage of the cycle, a more deliberate approach is to consider active strategies that can selectively allocate across regimes, countries, and balance sheets. This means treating the index as a reference point rather than the destination.