Sfor foreign Investors in China are most concerned about the country’s deteriorating relations with the West. Others are concerned about the unprecedented slump in the real estate market. Many are simply tired of losing money. Rumors that officials are considering steps to stabilize the country’s markets may have provided some relief in recent days, but over the past year the CSI 300 index of Chinese stocks fell 22% and Hong Kong’s Hang Seng index fell 30%.
As such, optimism about China Inc is an increasingly distant memory. But just five years ago, investors were clamoring for exposure to the country’s growth miracle and seeking diversification from the rich world’s markets, which often move in sync. Providers of the world’s major stock indices made adjustments accordingly. Between 2018 and 2020, Chinese stocks were listed in the country, known as ashares, were added to the emerging markets benchmark index.
At their peak in 2020, Chinese companies made up more than 40% of the total economy MSCI emerging markets index by value. In 2022, foreigners owned $1.2 trillion worth of stocks, or 5-10% of the total, in mainland China and Hong Kong. One financier describes the challenge of investing in emerging markets while avoiding China as being like investing in developed markets while avoiding America. But that hasn’t stopped investors from assessing their options.
Some financial companies are happy to help. Jupiter Asset Management, Putnam Investments and Vontobel all launched actively managed ‘ex-China’ funds in 2023. An exchange-traded emerging markets fund, ex-China (etc) issued by BlackRock is now the fifth largest emerging market stock etcwith $8.7 billion in assets under management, up from $5.7 billion in July.
A handful of emerging stock markets are benefiting from this. Money has flowed into India, South Korea and Taiwan, whose shares account for more than 60% of emerging market stocks excluding China. These markets received $16 billion from foreign investors in the last three months of 2023. Together, Squint and the countries look a bit like China: a fast-growing middle-income country with the potential for massive consumption growth (India) and two that are home to advanced industry (Taiwan and South Korea).
Western investors seeking exposure to China’s industrial stocks are also turning to Japan, encouraged by corporate governance reforms. Last year, foreign investors poured ¥3 trillion ($20 billion) into Japanese stock funds, the most in a decade. For those with broad mandates, different asset classes are an option. Asia-focused funds that invest in real assets, including infrastructure, have grown in popularity.
Yet these different alternatives have their own shortcomings. Unlike Chinese offerings, Indian stocks are expensive. They have a higher price-to-earnings ratio than those in other major emerging markets. Although Japanese stocks look relatively cheap, they are an odd choice for investors looking for fast income growth. Similarly, Taiwanese and South Korean stocks are considered emerging markets due to the relative illiquidity and inaccessibility of their exchanges, but both economies are mature, high-income economies.
Size is also an issue. Many of the places benefiting from supply chains moving away from China have puny public markets. Even after rapid growth, India’s total market capitalization is just $4 trillion – less than a third of Hong Kong, Shanghai and Shenzhen combined. When MSCI When Malaysia published its emerging markets index in 1988, Malaysia accounted for a third of its stocks by value. It now represents less than 2%. Brazil, Chile and Mexico together made up a third; today they make up less than 10%.
And while returns on Chinese investments tend to follow their own logic, smaller economies are more exposed to the vagaries of the dollar and US interest rates. According to research by UBS In asset management, Chinese stocks had a correlation of 0.56 with those in the rich world between December 2008 and July 2023 (a score of one indicates stocks rising and falling simultaneously; zero indicates no correlation). In contrast, emerging market stocks excluding China had a correlation of 0.84 with rich world stocks.
The rise and growth of funds that promise to exclude China will make life easier for investors looking to avoid the world’s second-largest stock market. Without a turnaround in the country’s economic fortunes, or a lasting easing of tensions between Beijing and Washington, interest in such strategies will increase. However, they will not generate the enthusiasm that investors once felt about China. ■
Editor’s Note (January 23, 2024): This article has been updated due to market movements.
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