Australia
China
India
Indonesia
Japan
Malaysia
Philippines
Singapore
South Korea
Taiwan
Thailand
Vietnam
China, because of the size and significance of its capital markets, is traditionally a part of emerging market (EM) portfolios. However, Invesco points out an increasing trend to separate China from EMs to invest separately or exclude Chinese assets completely. “Emerging markets ex-China are offering investors substantial investment opportunities, helping them diversify portfolios and reduce country concentration risk,” stated James McDermottroe, Fund Manager at Invesco.
McDermottroe explained that it’s quite common to exclude sizeable markets such as China from broad regional equity strategies. In 2001, for instance, MSCI removed Japan and launched the Asia ex-Japan index. “Emerging markets without China can be considered a nascent version of Asia ex-Japan, and we believe investors should have the option to choose what’s most suitable to them,” opined the Fund Manager.
According to the American investment management company, excluding China helps to reduce country concentration risk in portfolios as the nation now represents nearly 30% of the emerging market index compared to 5% two decades ago. Moreover, as several investors already have separate equity exposure to China, emerging markets ex-China helps to avoid duplication. The asset manager further emphasised this removal also mitigates Chinese-specific political, regulatory, and geostrategic risks.
Looking at the MSCI EM Index, IT witnessed an increase comprising 27% after China’s exclusion, while financials and energy had 24% and 6%, respectively, highlighted Invesco. On the other hand, the allocation to consumer discretionary and communication services was reduced.
The exclusion of China from the emerging market index also offers advantages to other geographies. “Looking at the index differences by country and region, removing China results in modestly higher exposure to EMEA and Latin America,” explained McDermottroe.
That said, he highlighted that the index without China results in over a 10% lower exposure to Asia. However, all non-China countries in Asia, especially India, South Korea, and Taiwan, increased.
Taiwan and South Korea are gaining a lot of attraction due to their emergence as prominent semiconductor hubs. Invesco further emphasises that both countries are particularly witnessing excitement around the launch of AI-related opportunities. “We believe the level of semiconductor demand needed to support the growth of AI has not been fully priced into the mega-cap Asian tech stocks,” McDermottroe contends.
Highlighting South Korea, the asset manager spoke about the country’s improvements in corporate governance and dividend pay-outs, which are yet to be priced in by the market. “In 2024, we expect to see a positive turn in the semiconductor cycle and a pick-up in earnings growth from the trough.”
In terms of performance, Invesco doesn’t see a material difference due to the exclusion. As per the asset manager, over the last decade, both China and emerging ex-China equities have witnessed similar returns.
However, the fund manager reminds investors that China has significantly underperformed over the past few years. “There are ample stock picking opportunities within emerging markets without China to continue generating excess returns,” McDermottroe concluded.
