The boom in emerging market technology stocks is becoming a problem for fund managers of all stripes.
The soaring market capitalization of a handful of companies such as China's Alibaba and Tencent is steadily lifting their weighting in the MSCI emerging equities index. This means investors in funds that track indexes—such as exchange-traded funds—who want exposure to a range of companies for a lower fund management fee are finding themselves increasingly exposed to a single sector.
Meanwhile, active fund managers, who justify charging higher fees for their individual stock-picking expertise, are under pressure to buy those tech stocks to ensure their funds keep up with the index's gains.
And with both sets of investor chasing the same thing, the risk of dramatic outflows increases if the sector falters.
"It's the opposite of what you are trying to do with an ETF—you want cheap diversified exposure but you end up being concentrated in basically 10 stocks," said Rory McPherson, head of investment strategy at Psigma, who holds active EM funds.
The biggest five emerging market companies in the index are tech firms Alibaba, Tencent, Samsung, Naspers and Taiwan Semiconductor.
They comprise almost 19 percent of the index's market capitalization. That is a bigger chunk than the S&P 500 where the top five firms—Alphabet , Apple, Facebook, Microsoft, and Amazon—make up 13 percent.
The increasing use of ETFs has helped boost valuations further because they must follow the index weighting.
And the index’s concentration has intensified as valuations rose—the five companies' share was 13.9 percent in January.
Discomfort