Investment managers across Asia are facing an unusual problem: their most successful stock picks have become too big to hold onto.
Sam Konrad, who manages Asian investments at Jupiter Asset Management, exemplifies this challenge. Despite stellar performance from artificial intelligence-driven companies in Taiwan and South Korea, his fund’s concentration rules are forcing difficult decisions.
“We have been forced sellers of TSMC, Samsung and MediaTek,” Konrad explained, referring to semiconductor companies that have surged 52%, 159% and 184% respectively this year.
The root of the problem lies in extreme market concentration. Three Asian technology giants – TSMC, Samsung and Korean memory chipmaker SK Hynix – now represent nearly one-third of the MSCI Asia Pacific ex-Japan Index. This level of dominance exceeds what most active investment funds consider acceptable risk.
This mandatory selling by funds like Konrad’s represents just one consequence of a rally driven primarily by a small number of companies. The situation has created market distortions while the required selling has intensified pressure on South Korea’s struggling currency.
Research from HSBC indicates that TSMC has become the largest underweight position among Asian and global emerging-market funds, as the region’s historic rally warps equity benchmarks and makes it difficult for portfolio managers to maintain pace.
The risks of such concentration became evident during recent sharp declines, with South Korean equities dropping 12% and Taiwan falling 6% over three trading sessions from record peaks as investors grew concerned about artificial intelligence valuations.
Profit growth expectations have pushed TSMC to represent 41.5% of Taiwan’s TAIEX index, while Samsung and Hynix constitute 55% of South Korea’s KOSPI. These indexes have essentially become wagers on one or two companies, undermining their purpose as diversified market representations.
This concentration makes it even harder for active managers to outperform these benchmarks.
Herald Van der Linde, who leads equity strategy for Asia Pacific at HSBC in Hong Kong, described the concentration level as creating “structural challenges.”
“As equities continue to outperform, funds will find it increasingly difficult to add exposure, reinforcing a cycle of forced selling and enlarging underweight positions even amid strong fundamentals,” Van der Linde noted in research commentary.
Adding to the complexity, many top alternatives to these three stocks remain connected to artificial intelligence themes, meaning sector diversification hasn’t improved returns. Information technology shares have dominated regional gains with explosive growth, while other sectors including consumer staples and healthcare have underperformed, according to Goldman Sachs analysis.
The same pattern appears at the country level. While the MSCI Asia Pacific ex-Japan index has climbed 27% year-to-date, excluding Korea and Taiwan shows a 4% decline, the bank reports.
This dynamic mirrors developments in the United States, where the “Magnificent Seven” technology stocks represent roughly one-third of the S&P 500 index and have drawn investor money from active funds into passive, market-tracking alternatives.
However, Asia’s concentration is more severe, developed more rapidly, and has accelerated the shift toward passive investing.
During the past five years, Asia’s active funds have experienced $269 billion in cumulative outflows, while passive funds attracted $510 billion, with one-quarter of that influx occurring in just the last six months, according to BNP Paribas analysis of EPFR data.
“The size of recent inflows into the region’s passive funds … has no precedent across the last 10 years,” said William Bratton, who heads cash equity research for Asia-Pacific at BNP Paribas Securities.
In response to these concentration challenges, stock selectors have moved deeper into the artificial intelligence supply chain, purchasing smaller companies while highlighting advantages of investment approaches that don’t passively track imbalanced market indexes.
Isaac Thong, senior investment director for Asian equities at Aberdeen Investments, has recently acquired ASMPT and Grand Process Technology Corp, both mid-sized suppliers to chipmaking companies.
Jupiter’s Konrad favors larger companies and has allocated nearly half his fund to Taiwan and South Korea. His holdings include electronics manufacturers Hon Hai and Quanta, plus SK Hynix, with his largest position in chip designer MediaTek.
“Our funds are very different to the benchmark, and the way we invest very different to our peers, which we think has helped us to outperform,” Konrad stated.
Asia’s concentration risk has grown more severe than when Baidu, Alibaba and Tencent were market favorites and comprised 37.14% of the narrower MSCI China benchmark at their October 2020 peak.
The turbulence driving fund flows is also historically unprecedented in magnitude.
Portfolio rebalancing by foreign investors generated a record $27.9 billion outflow from South Korean stocks in May, exchange data revealed, while simultaneously Nomura tracked an unprecedented $20.4 billion year-to-date inflow from U.S.-based funds into South Korea and Taiwan.
“The relentless rally since April has increased concentration risk in Asian equities that we have never seen before,” said Rupal Agarwal, Asia quantitative strategist at Bernstein.
