Launches of emerging-market equity funds that exclude China have already reached a record annual high in 2023, as investor concerns grow over weak returns as well as the risks of investing in the nation.
Fourteen such funds have started this year, following last year’s count of 13, according to data compiled by Bloomberg. The latest launches include vehicles from Wall Street titans including Goldman Sachs Asset Management, BlackRock Inc. and Lazard Asset Management.
The trend is another signal of China’s declining heft in the global money pool, following a record outflow from the nation’s stocks last month. Doubts over the investability of Chinese equities have gathered steam as Beijing’s efforts to restore confidence have limited impact and as the West steps up oversight of exposure to Asia’s largest economy.
Exclusion from EM funds “sends a signal to investors that China is no longer a reliable investment destination,” said Manish Bhargava, a fund manager at Straits Investment Holdings in Singapore. While it’s too early to talk about the long-term impact, “this is a significant development that will have implications for investors, businesses, and policymakers alike.”
Poor performance is certainly a concern, with the MSCI China Index down about 6% this year compared with a 12% gain in a measure of global peers as reports of the nation’s economic woes continue to multiply. Regulatory backlash is also a factor, with US financial firms bracing for tighter government oversight of China investments.
MSCI Inc. launched its EM ex-China index in 2017, but the strategy took off in the past three years amid Beijing’s draconian Covid restrictions, an underwhelming reopening recovery and heightening geopolitical tensions with the US. The ex-China gauge is up 37% since its inception compared with a 6% rise in MSCI’s broadest index of global emerging markets.
Total assets held in the iShares MSCI Emerging Markets ex-China ETF have swelled to about $5.2 billion from a meager $164 million at the end of 2020, according to data compiled by Bloomberg. In comparison, the market value of the iShares MSCI China ETF has increased by just 15% to around $7.5 billion over the same period.
While some emerging-market money managers are completely excluding China from funds, others are replacing the nation as a preferred bet in their portfolios. But while EM funds’ underweight position in Chinese equity is on course to increase for a third-straight quarter, this might not be the best bet, according to Bloomberg Intelligence.
To be sure, the cheap valuations of Chinese stocks have now started attracting some interest from funds. Hillhouse is gauging international investor interest for what is expected to be a multi-billion dollar fund to buy beaten-down Chinese stocks, according to people familiar with the matter who asked not be identified discussing private information.
“Excluding China from emerging market portfolios has proven a winning fund strategy this year that’s drawing a flood of investors,” BI strategists Kumar Gautam and Sufianti Sufianti wrote in a note. They caution however that this “results in less-than-optimal portfolios that risk losing the opportunities that come from diversification.”
While China is being carved out from allocation, focus on other EMs is growing. India and Taiwan combined now command more weight than China in the MSCI Emerging Markets Index. That’s a big change from October 2020, when it took five markets to match China’s weighting.
