Investing in emerging markets without including China is akin to baking bread without yeast; it’s a significant choice that could yield uncertain results.
Several fund managers, including Abrdn with its revamped Emerging Markets Sustainable Equity fund, are now focusing on emerging markets while excluding China’s substantial influence. What prompted this shift?
Historically, emerging markets have thrived due to their rapidly expanding economies fueled by youthful demographics and a growing middle class. While China has been a major contributor to this growth, countries like India and South Korea are increasingly becoming the focal points.
Two decades ago, Chinese companies represented roughly 5% of the MSCI emerging markets index. Due to extensive growth, this figure surged to approximately 25% today, where almost half of the index’s 1,328 companies are Chinese.
However, greater representation doesn’t always translate to superior performance. Over the last year, the index grew by 21% and by 5% over five years. Currently, China accounts for 24%, India for 20%, Taiwan for 19%, and Korea for 12%.
The MSCI emerging markets index, which excludes China, redirects investments within the same region yet omits Chinese stocks. This index showcases India as the leading nation at 26%, followed by Taiwan at 25%, Korea at 15%, and Brazil at 6%. Over the past year, this index has appreciated by 27% and by 9% over five years.
India’s performance has been buoyed by its youthful population and governmental reforms, making it the third largest consumer market globally, following the US and China. The nation also remains a favored destination for businesses looking to outsource IT due to its affordable yet skilled English-speaking workforce.
On the other hand, Taiwan and Korea boast some of the world’s leading tech firms. Taiwan Semiconductor is a critical supplier for firms such as Apple, while Samsung continues to dominate the global electronics space.
Given the underperformance, uncertain economic forecasts, and governance issues, it’s understandable that some investors choose to sidestep China, especially with its neighboring countries appearing more attractive.
This trend isn’t entirely new. For instance, Japan frequently gets excluded from broader Asia-focused funds due to its economic and market maturity, which often sets it apart from its regional counterparts.
One might argue that a nation with a GDP of $4 trillion challenges the traditional definition of an emerging market. This perspective, however, could extend to other emerging economies where the link among countries like South Africa, Brazil, and Taiwan is tenuous, especially considering their shared status as non-developed.
Investors also have reasons for excluding China from their emerging market strategies. Ongoing trade tensions between the US and China, compounded by threats of heightened tariffs, add to these concerns. Additionally, uncertainties regarding China’s potential actions towards Taiwan, coupled with a challenged property market, aging population, and rising youth unemployment at 19%, make China less appealing. Many multinationals are also relocating their manufacturing closer to their home bases.
Nonetheless, completely excluding China from one’s investment strategy is a substantial decision. The country continues to constitute about 19% of global GDP and 16% of all publicly traded companies.
There are also positive indicators; early-year economic growth exceeded expectations, and recent government efforts have introduced a robust stimulus package aimed at further growth.
Investors looking for exposure in emerging markets have various choices. A straightforward option remains investing in a broad index that includes China via a tracker fund or an Asia-focused fund.
Alternatively, one might choose to hold a fund that excludes China alongside a specific China-focused fund, thereby allowing for better control over their investments.
Another approach involves delegating investment decisions to professionals. For example, the Jupiter Asian Income fund has the mandate to invest in China but its manager, Jason Pidcock, currently has no allocations there, possibly awaiting a more opportune moment.
My own stake in China is limited, represented by a 7% allocation within the Pacific Assets investment trust. This feels sufficient to me, considering China remains the second-largest economy with significant companies like Alibaba, Tencent, and Ping An. Completely disregarding it may not be a wise strategy.