With or Without China

December 6, 2021 | By: Regina Chi

With or Without China

The case for investing in the world’s second largest economy is strong. So too is the case for investing in Emerging Markets outside it.

Chinese equities in 2021 have hardly lived up to the promise of one of the world’s fastest-growing large economies rebounding from the depths of the COVID-19 pandemic. As of October 31, the MSCI China Index, which captures more than 700 large- and mid-cap companies, was down about 14% in U.S. dollars on the year, according to Factset. By the standard of some other large Emerging Markets (EMs), that is bad. Over the same period, the MSCI Indonesia index was up more than 4%, while MSCI India rose by more than 25%, MSCI Argentina by more than 34% and MSCI Russia by more than 37%.

Perhaps even more concerning for EM investors is the possibility that this underperformance is not just a blip. To many observers, China’s government turned more hardline in 2021 on a host of economic and political fronts, from increased regulation on digital-economy firms and an emphasis on wealth-sharing “Common Prosperity” goals to its stand on human rights in Xinjiang province and its contentious position on independence for Taiwan. Those are all potential headwinds for China equities as a group. And when you add in trade tensions with the West, it is not surprising that some Westerners are wondering out loud whether China is uninvestable.

The answer to this question is no. After all, “getting out” of China would mean turning one’s back on the potential of the world’s second largest economy, which is on track to become the world’s largest before 2030, according to the World Bank. It would also mean missing the investment opportunities presented by the largest middle class in the world, and China’s body of 400 million middle-income consumers is growing. Yet for some investors, that long-term potential might not be enough to keep them exposed to a market over which they have deep economic, political or ethical concerns. So it is worth asking the question: What would an Emerging Markets allocation strategy look like without China?

World’s Largest Economies by 2030 (Ranking in Nominal GDP)

graph showing the world's largest economies in 2020 versus the projection for 2030
Source: Centre for Economics and Business Research, World Economic League Table 2021

When we ponder that question and look at China equities’ current share of broad EM indexes, a couple of things become readily apparent. One is that China looms large – perhaps too large. Another is that setting China aside from other Emerging Market allocations could produce a more diversified, more balanced portfolio. It may also present investors with significant upside in capturing an important secular trend: the digitization of emerging economies.

First, let’s look at just how big China is within the most widely followed EM indexes. China equities comprise 34% of the MSCI EM index – more than twice the next-largest market, Taiwan, at 15% – and 36.5% of the FTSE EM index, according to both index providers. At the market’s peak, China represented more than 40% of both. That in itself represents heightened concentration risk, but a related issue is that EM index investors also face heightened regional concentration because of the size of the China allocation. Regionally, 78% of the MSCI EM index is allocated to Asia stocks, with 14.3% to EMEA (Europe, Middle East and Africa) stocks and only 7.3% in South America. Take China out of the equation, however, and those regional outliers become more important. In an ex-China EM allocation, Asia’s share falls to 67%, while EMEA’s rises to 21.6% and Africa’s to 11.1%. An ex-China strategy would still be skewed towards Asia, but much less heavily so.

Excluding China, then, could provide better diversification across EM regions. It could also be more balanced across specific markets. As mentioned above, China dominates within the EM index, with a nearly 20-percentage-point weighting difference over the next-largest market. In an ex-China strategy, however, the top three countries achieve roughly equivalent weight: India, Taiwan and Korea all comprise around 20% of the total allocation. That more balanced weighting might be especially important regarding India because its stock performance has tended to be less correlated with China than, say, Korea’s or Taiwan’s.

Yet the potential benefits of an ex-China strategy go beyond better diversification and a more balanced EM portfolio. Getting out from under the weight of China allocations might also open up secular opportunities in other markets. Consider e-commerce, one of the great yet-to-be-realized opportunities for EM investors – outside of China, at least. According to the MSCI China index, it’s dominated by three big players in the Internet and consumer retail/technology space, sectors that account for 45% of the index. Before 2021, China’s digital economy stocks were high-flyers as e-commerce boomed, and Internet retailing already makes up 24% of total retail sales in China. But with rising regulatory scrutiny, future sector growth – and the upside for China’s e-commerce stocks – might well be capped. This is not the case elsewhere in Emerging Markets. In India, for example, Internet retailing accounts for only about 7% of total retail sales, and in the MSCI EM index excluding China, Internet and consumer retail/technology companies comprise only 6% of allocations. It may be that e-commerce will grow across developing economies, but it has more room to grow – and may grow faster – in markets outside of China.

Looking at EM allocations in this way may or may not convince investors to “get out” of China – which, we hasten to add, is not our primary goal. But it clearly suggests that they may benefit from looking at China’s influence on EM performance in a different light. For instance, U.S. stocks account for more than 60% of the MSCI World index, creating even more concentration risk than China does in the EM index. To address that, investors have increasingly adopted a strategy of making discrete allocations to the dominant U.S. market while gaining exposures to developed markets outside the U.S. through vehicles like the MSCI World ex-U.S.A. and MSCI EAFE (Europe, Australasia, and Far East) indexes. A similar approach with China might provide similar sectoral and geographical diversification and portfolio balance advantages, while allowing investors to pursue specific opportunities in China.

On a broader level, this EM ex-China exercise demonstrates some of the pitfalls of lumping Emerging Markets together under one opportunity set. More than some other asset classes, EM equities’ performance and potential are functions of local political, economic and social factors that no broad index – however useful it is as a benchmark – can hope to fully capture. Emerging Markets are not all the same, and China is unlike any other EM. Rather than abandoning China altogether, recognizing that reality might be a more prudent way to begin to address its risks and its potential, while opening the door wider to opportunities elsewhere.


Regina Chi
Regina Chi, CFA®
Vice-President and Portfolio Manager
AGF Investments Inc.
Vice-President and Portfolio Manager

Regina Chi has lead responsibility for AGF’s Emerging Markets strategies. She looks for quality companies with fundamental catalysts and long-term sustainable competitive advantages at attractive valuations. Regina is a member of the AGF Asset Allocation Committee, a group of senior investment professionals that meet quarterly to discuss, analyze and assess the macroeconomic environment and capital markets to determine optimal asset allocations. She also serves as co-Chair of AGF’s Diversity and Inclusion Committee, which develops, creates organizational awareness around and promotes best practices related to diversity and inclusion across the firm.

Regina brings more than 25 years of international equity experience to this role. Prior to joining AGF, Regina was a partner at a boutique U.S. investment firm, where she served as portfolio manager for the Emerging Markets and International Value disciplines. She was also head of portfolio management and research as they related to Emerging Markets, Global, International and International Small Cap strategies. Prior to this role, she held senior investment management roles at several large and boutique investment firms in the U.S.

Regina is a CFA® charterholder. She received her Bachelor of Arts in Economics and Philosophy from Columbia University. She is also a member of 100 Women in Finance, an organization working to strengthen the global finance industry by empowering women to achieve their professional potential at each career stage.

Registered as a Portfolio Manager under AGF Investments Inc. and AGF Investment America Inc. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

The commentaries contained herein are provided as a general source of information based on information available as of December 6, 2021 and are not intended to be comprehensive investment advice applicable to the circumstances of the individual. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained here.

The views expressed in this document are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

References to specific securities are presented to illustrate the application of our investment philosophy only and do not represent all of the securities purchased, sold or recommended for the portfolio. It should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by AGF Investments. Diversification does not guarantee a profit or eliminate the risk of loss. An investment cannot be made into an index.

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