Emerging markets: Why excluding China can sometimes make good sense

A look at why some investors are increasingly turning to emerging markets (EM) excluding China, seeking greater control and alignment with global economic shifts.

AUTHOR Nick Robinson Senior Investment Director, Global Emerging Markets Equities

In an evolving global financial landscape, investors are increasingly seeking strategies to give them greater control over their portfolios.

One strategy gaining traction is investing in emerging markets (EM) while excluding China. This approach offers a host of benefits and aligns with the shifting dynamics of global economic growth.

Find out more about some of these trends by watching this video:

Why the shift?

Historically, China has played a pivotal role in the narrative of EM development due to its rapid economic growth and significant contributions to global trade. 

Despite the potential opportunities in China, as its market matures and economic policies evolve, many investors are reassessing their exposure to Chinese equities by either aiming to reduce their exposure(s) or separate them from their other investments.

There are many reasons behind this shift in their thinking, including geopolitical, economic, and strategic considerations.

Managing China exposure

One of the primary reasons for adopting an EM ex-China strategy is the desire to manage China-related exposure on one's own terms. 

Unlike many EMs, China's economy and corporate governance are heavily influenced by state policies, which can introduce uncertainty and volatility. For instance, regulatory crackdowns on homegrown technology giants and real estate developers have led to significant market disruptions. 

By excluding China from their EM portfolios, investors can mitigate these risks and take more control of tactical asset allocation. Doing this can deliver performance and diversification benefits.

Performance

Actively managed EM ex-China portfolios can and have beaten both the MSCI index, which tracks the entire emerging market universe (including China), and the corresponding benchmark, which excludes it.¹ Something we have seen firsthand with our own portfolio since early 2022.

This performance has been driven by robust earnings growth in these emerging economies, which is expected to continue outpacing that in developed markets (DM) this year. Additionally, these markets benefit from favorable demographics, rising consumption, and technological advancements.

Diversification

Excluding China from an EM portfolio can enhance diversification benefits. The ex-China universe offers some unique investment opportunities, particularly in areas such as information technology (IT) and financial services. 

Most notably, EM markets like India, Taiwan, and South Korea are home to leading companies that play critical roles in the tech global supply chain. That’s why we expect tech companies' impressive stock performance to expand beyond the US markets. For example, the MSCI EM ex-China Index includes more IT and financial stocks compared to the MSCI EM Index – offering investors a different risk-reward profile.¹

Themes currently driving EM ex-China

Several powerful themes are shaping the investment landscape in emerging markets ex-China, making them attractive options for long-term investment strategies:

• Consumption  
  Rising domestic consumer spending is a significant driver of growth in many EMS. Countries like India are witnessing a surge in the number and spending power of middle-class consumers, which fuels demand for goods and services. This structural change in consumption habits, accelerated by the pandemic, has led to increased online shopping and other modern retail experiences.
• Technology  
  Technological innovation is another critical theme. North Asia, particularly Taiwan and South Korea, dominates global semiconductor production, which is essential for various tech applications, from artificial intelligence (AI) to consumer electronics. India's IT services sector is also on a strong growth trajectory, poised to capture significant market share in the coming decade.
• Energy transition  
  The global shift towards sustainability and green energy presents immense opportunities in emerging markets. Latin America, for example, is rich in minerals, such as copper and lithium, that are critical for the energy transition movement. These resources are in high demand as the world moves towards renewable energy sources and the electrification of transportation.
• Nearshoring  
  Supply chain reconfigurations are another theme benefiting EM ex-China. As companies seek to reduce reliance on China, they are turning to other EMs for manufacturing and supply chain solutions. Mexico, for instance, is seeing increased investment in its industrial sector driven by these trends and is now the biggest source of US imports.

Why now?

The timing for investing in EMs, excluding China, is good. Global capital expenditure is finally on the rise after years of neglect in many countries. When this has happened before, EMs were big beneficiaries. 

Additionally, even though expectations have been lowered, anticipated interest rate cuts by central banks this year will help support equity markets. This is especially true in EMs where macroeconomic conditions are, in many ways, in better shape than in developed markets.

EM ex-China stock valuations are also at multi-decade lows compared to developed markets. Despite the popularity of the Indian market, we believe there are still overlooked opportunities in larger Indian consumer and bank stocks. Low valuations provide a favorable entry point for investors. Low prices, combined with dividend payout expectations, mean greater potential for gains.

Final thoughts

China's economic influence is undeniable, driving global growth and innovation. However, focusing on other EMs can diversify investments, reduce dependency on a single country, and uncover new opportunities. By excluding China from an EM portfolio, investors can swing the spotlight onto under-represented regions and tap into unique, high-potential markets. Investors can focus on diverse regional opportunities, benefiting from compelling long-term themes such as consumption, technology, the energy transition, and nearshoring. As the global economic landscape continues to evolve, EM ex-China strategies present a viable and often attractive option for investors seeking to construct a forward-looking portfolio.  
 

1 The MSCI Emerging Markets ex China Index captures large- and mid-cap representation across 23 of the 24 Emerging Markets (EM) countries excluding China.  
 

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