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Emerging market tech stock boom gives fund managers a headache

Emerging market tech stock boom gives fund managers a headache
From Reuters - October 10, 2017

LONDON (Reuters) - 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 Chinas Alibaba (BABA.N)and Tencent (0700.HK) is steadily lifting their weighting in the MSCI emerging equities index .MSCIEF.

This means investors in funds that track indexes (exchange traded funds or ETFs)- 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 indexs gains.

And with both sets of investor chasing the same thing, the risk of dramatic outflows increases if the sector falters.

Its 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 (005930.KS), Naspers (NPNJn.J) and Taiwan Semiconductor (5425.TWO).

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 (GOOGL.O) , Apple (AAPL.OQ), Facebook (FB.O), Microsoft (MSFT.OQ), and Amazon (AMZN.OQ) - make up 13 percent .SPX.

The increasing use of ETFs has helped boost valuations further because they must follow the index weighting.

And the indexs concentration has intensified as valuations rose - the five companies share was 13.9 percent in January.

DISCOMFORT

The shift toward passive investing, evident across most asset classes, has come into focus in emerging equities, which have enjoyed a sparkling 60 percent rally since early-2016. But the sector may also illustrate the concentration risks that exchange-traded funds can bring to portfolios.

Emerging equity funds have received some $56 billion so far this year, Lipper data shows. Of this, $23 billion went into ETFs.

Investors are keen on tech companies which are making profits by disrupting the status quo in sectors from media and advertising to retail and industrials.

But the dependence on technology for returns is causing some discomfort among investors who prefer shares in emerging market car or beverage makers for instance for exposure to consumer demand in the developing world.

Ed Kerschner, chief portfolio strategist at Columbia Threadneedle, says the tech companies performance mostly reflects that of their U.S. peers rather than providing exposure to developing countries.

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