Emerging markets equity ETFs have delivered strong double-digit returns in 2026, outpacing the S&P 500. For many investors, this performance has been a welcome surprise. Yet, beneath the surface of these gains lies a structural shift that warrants a closer look. The primary driver of this momentum is the global artificial intelligence boom. This tech surge has heavily concentrated returns in specific regions and sectors. As a result, the diversification benefits often associated with emerging markets (EM) allocations are eroding. Investors may find that their broad EM exposure is less diversified than expected.
The Concentration Problem
The MSCI Emerging Markets Investable Market Index, tracked by IEMG, has led the charge. However, this success is tied to a narrow group of players. Taiwan and South Korea now represent more than 45% of core EM equity index weights. When China is added to the mix, these three countries account for roughly 70% of the broad benchmark’s geographical exposure. This geographic narrowing mirrors the single-stock concentration seen in U.S. large-cap tech.
Technology is the single largest sector in this popular benchmark. It represents about 40% of the index’s sector weights. The concentration is stark: 25% of the portfolio is tied to just three tech names: TSMC, Samsung, and SK Hynix. A third of the entire benchmark sits in just five stocks. This level of single-name risk is unusual for a broad market index. It suggests that the “broad” label may be misleading for those seeking true diversification.
Emerging markets have long been a favorite for portfolio diversification. Investors typically allocate to these regions to gain access to growth outside the U.S. and Europe. Ironically, the same single-name and sector-concentration concerns that have plagued the U.S. equity market are now evident in EM benchmarks. Headed into the tail end of the third quarter, these indices are just as narrowly focused. Concentration is now a growing concern across the emerging market equity universe. It is no longer just an American problem.
Valuation and Growth Potential
Despite the concentration risks, the fundamental case for EM equities remains strong. There is a significant valuation discount relative to the developed world. EM equities continue to trade at about a 45% discount to developed market equities on a price-to-book basis. They also trade significantly below the forward P/E multiples of the S&P 500. This gap offers a margin of safety and room for relative multiple expansion. If valuations normalize, the upside potential is substantial.
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Growth projections also favor this segment. Analysts expect EM stocks to outpace developed markets in earnings growth. This outlook is driven partly by the AI supply chain needs. It is also fueled by demographic trends, ongoing structural growth, and strong domestic consumption. Key markets such as India are leading this charge. The combination of low valuations and high projected growth creates an attractive risk-reward profile. The challenge lies in capturing this growth without taking on excessive concentrated risk.
For many portfolio managers, the appeal of EM lies in its role as a diversifier. A recent advisor poll conducted in a webcast with Pictet Asset Management suggested that diversification remains a key driver of investor allocation to these markets. This makes the rising concentration a critical issue to consider. If the primary goal is to reduce correlation with U.S. markets, holding a portfolio heavily weighted toward the same AI hardware suppliers as the S&P 500 may not achieve that objective. The structural overlap is significant. It suggests that traditional broad EM ETFs may no longer serve their original purpose for many investors.
Alternative Strategies
The world of EM equity ETFs is vast, and there are various approaches to address these concerns. Investors can choose from broad-based index trackers, exclusionary funds, or active strategies. IEMG is the largest, with about $150 billion in assets, tracking the MSCI EM Index. These funds provide full-market access but inherit the high concentration of the underlying indices.
Choosing the right vehicle depends on individual goals. No single choice fits all. However, understanding the composition of your ETF is essential. Whether you select a broad index fund or a specialized active strategy, the key is to know what you own and why. The EM equity universe remains compelling, offering attractive valuations and strong growth potential. But the level of diversification varies widely depending on the specific ETF chosen. Investors should review their holdings to ensure they align with their current risk tolerance and diversification needs.
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