Emerging Market Funds: China Exclusion Opportunity or Risk?

Emerging market funds excluding China have seen significant growth in assets over the past decade, driven by investor sentiment and structural shifts due to China's economic and regulatory issues. Despite this, China is likely to remain a standalone allocation in the future, similar to Japan. Investors should be aware of the risks when opting for ex-China funds, as they may limit access to China's equity and growth potential.

Emerging market funds excluding China have witnessed a significant surge in assets over the past decade, driven by investor sentiment and structural shifts stemming from China's economic and regulatory issues. According to Morningstar, these funds have grown from USD 800 million to USD 25 billion in the last 10 years [1]. The Morningstar Emerging Markets ex-China Index has significantly outperformed the Morningstar China Index since January 2020, highlighting the appeal of these funds [1].

Investors have been drawn to emerging-market ex-China funds due to regulatory crackdowns, governance issues, and economic uncertainty in China. These funds offer diversification away from China's unique risks and exposure to other developing markets. However, using these funds to completely shun China brings several risks. 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 [1].

Despite the growth of ex-China funds, China is likely to remain a standalone allocation in the future, similar to Japan. This will solidify the emerging-markets ex-China category of funds. However, investors should be mindful of the risks associated with these funds. 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 [1].

Moreover, 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 [1].

JPMorgan's analysis reveals a compelling narrative for investors in consumer discretionary and healthcare sectors in China. While overcapacity and regulatory crackdowns pose risks, policy stimuli, valuation resets, and structural shifts are creating opportunities for those willing to navigate the noise [2]. For instance, healthcare firms like Wuxi Biologics and consumer discretionary firms like Anta Sports are positioned to benefit from policy clarity and structural demand.

Luxshare Precision Industry Co., a key supplier to Apple Inc., is also advancing plans to list in Hong Kong, signaling its ambition to secure global capital and expand its footprint in the tech supply chain [3]. This strategic pivot underscores the growing trend of Chinese tech firms seeking international financing amid geopolitical tensions and regulatory hurdles in Western markets.

In conclusion, emerging market funds excluding China have seen significant growth in assets over the past decade, driven by investor sentiment and structural shifts due to China's economic and regulatory issues. However, investors must be aware of the risks associated with these funds and the potential long-term opportunities in China's market.

References:
[1] https://global.morningstar.com/en-gb/funds/emerging-market-investing-rise-ex-china-funds
[2] https://www.ainvest.com/news/jpmorgan-bullish-call-chinese-consumer-stocks-regulatory-crackdowns-overcapacity-concerns-2507/
[3] https://www.ainvest.com/news/luxshare-precision-hong-kong-listing-strategic-leap-global-tech-dominance-2507/