AI chip stocks’ rally distorts Asian benchmark indices, active funds trapped in a “the higher it rises, the more they sell” cycle.

AI chip stocks’ rally distorts Asian benchmark indices, active funds trapped in a “the higher it rises, the more they sell” cycle.

TSMC, Samsung, and SK Hynix—the three major AI chip stocks—together account for nearly one-third of the weight in the MSCI Asia Pacific (excluding Japan) Index. The concentration risk arising from this is forcing active fund managers to passively reduce their holdings once they reach the position limit, creating a vicious cycle of "the higher it rises, the more they sell." This has led to significant distortion in Asian benchmark stock indices.

Sam Konrad, Asian Equity Income Investment Manager at Jupiter Asset Management, admitted that their funds have "been forced to sell" TSMC, Samsung, and MediaTek—these three stocks have surged by 52%, 159%, and 184%, respectively, so far this year. TSMC accounts for as much as 41.5% of the Taiwan Weighted Index, while Samsung and SK Hynix together make up about 55% of the Korea Composite Index. This means that both flagship indices have essentially devolved into tools for betting on just one or two stocks, losing the diversification that benchmark indices are supposed to provide.

According to HSBC Research, TSMC is currently the largest underweight single holding in Asian and global emerging market funds. Herald Van der Linde, Head of Asia-Pacific Equity Strategy at HSBC, pointed out in a research report that such concentration creates a "structural challenge." As these stocks continue to outperform, funds will find it increasingly difficult to add exposure, perpetuating the "forced selling cycle."

The double-edged sword effect of concentration risk has already been reflected in recent declines—in the past three trading days from the historical peak, the Korean stock market has dropped 12%, and the Taiwan stock market has fallen 6%. According to exchange data, portfolio rebalancing among foreign investors led to a record net outflow of $27.9 billion from the Korean stock market in May, and forced reductions in active fund holdings have added extra pressure to the already strained Korean won exchange rate.

Forced Reduction Cycle Difficult to Break

Expectations of explosive growth in chip companies’ profits have pushed TSMC, Samsung, and SK Hynix into dominant positions within their respective benchmark indices, putting active fund managers in a dilemma: avoiding these stocks makes it difficult to outperform the benchmark, but overweighting triggers internal concentration limits, forcing reduction.

Herald Van der Linde wrote in his report: "As the stocks continue to outperform, funds will find it increasingly difficult to add exposure. This reinforces the forced selling cycle and continually expands underweight positions against a backdrop of strong fundamentals."

To make matters worse, most of the best-performing alternatives outside these three stocks are also strongly linked to the AI theme, so industry diversification strategies hardly yield substantial performance improvement. According to Goldman Sachs, the information technology sector has seen explosive gains, leading the Asia-Pacific region, while consumer staples and healthcare sectors have lagged significantly, leaving little room for sector rotation.

Goldman Sachs data shows the MSCI Asia Pacific (excluding Japan) Index has risen 27% so far this year, but if Korea and Taiwan are excluded, the index has actually fallen 4%. The gulf between the two clearly reveals how this rally is highly concentrated in a few markets and stocks.

Bernstein Asia Quantitative Strategist Rupal Agarwal stated: "The continuous rally since April has pushed concentration risk in Asian stock markets to unprecedented levels." Compared to the historical precedent when Baidu, Alibaba, and Tencent jointly held 37.14% weight in the MSCI China Index at the peak in October 2020, current concentration risk in Asia is even more severe and expanding faster.

Passive Funds Accelerate Erosion of Active Management Scale

The highly concentrated market structure is further accelerating the massive migration of funds from active to passive funds. According to BNP Paribas analysis of EPFR data, over the past five years, Asian active funds have seen a cumulative net outflow of $269 billion, while passive funds have had a net inflow of $510 billion, one-quarter of which occurred in just the last six months.

William Bratton, Head of Asia-Pacific Equity Research at BNP Paribas Securities, said the scale of recent inflows to passive funds in the region is "unprecedented in the past ten years." Nomura tracking data shows that funds registered in the U.S. have so far this year flowed into Korean and Taiwanese stock markets at a record volume of $20.4 billion.

Faced with the persistently distorted benchmark indices, some active fund managers have started to explore new paths—expanding downstream along the AI industry chain, building positions in small and mid-cap supporting suppliers, while emphasizing the differentiated advantages of active stock-picking strategies compared to passively tracking skewed indices.

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