Key Takeaways
- Ex-China fund assets have surged from USD 800 million to USD 25 billion in 10 years.
- Going ex-China reduces diversification and the opportunity set
- Since January 2020, the Morningstar Emerging Markets ex-China Index significantly outperformed the Morningstar China Index.
- Regulatory crackdowns, governance issues, and economic uncertainty in China have unsettled investors.
Emerging-market ex-China funds have grown rapidly in recent years, reflecting both structural and tactical shifts in investor sentiment. These funds are all relatively new and it’s hard to say if they are here to stay. The surge in their popularity is linked to China’s current woes, which may not last forever.
It’s likely that China will be treated as a stand-alone allocation in the future, possibly split from the rest of the developing world like Japan. This will solidify the emerging-markets ex-China category of funds.
But using these funds to completely shun China is a drastic move that brings several risks investors should be mindful of. Such a decision significantly reshapes sector and country exposures, amplifying weights in markets like India, Taiwan, and Brazil, while reducing exposure to China’s unique growth drivers and vast equity universe. This alters diversification benefits and reduces access to one of the world’s most inefficient—and potentially alpha-rich—markets.
China Markets Have Attractive Valuations
Furthermore, timing matters. China’s current valuation levels are attractive compared with other emerging markets, offering contrarian investors potential long-term upside. For long-term investors, combining emerging-market ex-China strategies with a reduced China allocation can strike a balance between mitigating risks and preserving access to China’s vast and idiosyncratic market.
Most investors would however be better off delegating that decision and opt for a global emerging-market fund managed by a skilled active manager capable of dynamically adjusting exposure to China in response to evolving risks and opportunities.
Granted, market-timing is a tricky exercise. But such a flexible approach may be better than completely avoiding China. It allows for the underweighting of China when warranted, without fully abandoning its long-term growth potential and alpha opportunity. In doing so, investors avoid the binary choice of inclusion versus exclusion, while retaining diversified and adaptable exposure to the broader emerging-market landscape.
This article has been taken from The Rise of ex-China Funds report.
