Emerging market stock volatility is declining at its most rapid pace in over six years, driven by a cooling of speculative trading in Korean tech shares and tighter regulatory measures, bringing a temporary close to the sharp turbulence triggered by the AI rally.

According to a Bloomberg report, the CBOE's implied volatility gauge for emerging market equities has dropped nearly 11 percentage points this month to 25%, marking the largest monthly decline since April 2020. The indicator had previously surged to a peak of 46% in July, when剧烈的 fluctuations in Asian semiconductor stocks boosted demand for hedging against an AI-driven selloff.

The swift retreat in volatility stems primarily from a concentrated unwinding of leveraged positions in the Korean market, rather than a fundamental shift in the outlook for technology companies. As retail investors gradually close out their positions and inflows into single-stock leveraged ETFs slow, market sentiment is turning more rational. Meanwhile, the premium of emerging market volatility over the US VIX has narrowed sharply from nearly 30 percentage points in July to less than 10 percentage points.

Leverage unwinding drives the volatility plunge

The root cause of the surge in the emerging market "fear gauge" lies in the leveraged AI rally earlier this year. The MSCI Emerging Markets Index had climbed 28% before peaking on June 22, with approximately 75% of that gain concentrated in just three companies: SK Hynix, Samsung Electronics, and Taiwan Semiconductor Manufacturing (TSMC). A large number of retail investors had borrowed funds to bet on AI stocks, and when the market reversed, they faced the dual pressure of margin calls and forced liquidation.

Varun Laijawalla, co-portfolio manager of emerging market equities at asset manager Ninety One, noted that the current decline in volatility appears to be the result of "position unwinding" rather than a shift in the fundamental outlook of tech companies, and the speed of this move is "consistent with a deleveraging process."

Heightened regulatory scrutiny has further accelerated this process. Since July 31, margin requirements for cash on single-stock leveraged ETFs have been raised, directly leading to a decline in both trading volume and assets under management for funds linked to Samsung Electronics and SK Hynix.

HSBC upgrades Korean stocks, citing earnings outlook

The slowdown in inflows into single-stock leveraged ETFs prompted HSBC Holdings PLC to upgrade its rating on Korean stocks to overweight last week. HSBC analysts pointed out that excess leverage has been flushed out of the market, while Korea's earnings growth prospects remain robust.

Investors generally maintain confidence in the long-term outlook for AI, but capital allocation strategies are quietly shifting. A growing number of fund managers are turning to secondary companies that have not fully benefited from the AI rally but stand to gain from the capital expenditure plans of US hyperscale cloud computing firms.

Laijawalla noted that within emerging markets, capital is flowing into sectors such as healthcare, financials, domestic consumption, and Latin America, "none of which have significant exposure to the AI capex cycle." Other investors are looking at growth sectors like Chinese biotech, or betting that a weaker US dollar will boost commodity demand, thus positioning in resource producers.

Risks remain; three major tech stocks still dominate the index

Despite the stabilization in market sentiment, underlying risks cannot be ignored.

The iShares MSCI Emerging Markets ETF, which serves as the underlying asset for the CBOE volatility indicator, still lists SK Hynix, Samsung Electronics, and TSMC as its largest holdings, collectively accounting for about 30% of the portfolio.

On the geopolitical front, the Iran conflict remains unresolved; on the monetary policy front, if the US Federal Reserve maintains a hawkish stance, it could push the dollar higher again, thereby pressuring emerging market assets.

For now, the decline in emerging market volatility is far outpacing that of the US market, and its premium over the VIX has narrowed significantly from July's highs. However, given the outsized weight of the three tech giants in the index, whether market sentiment can remain stable if the AI narrative shifts once again remains to be seen.