Removing exposure to the world's second-largest economy might not be such a bad move, says AGF VP and portfolio manager
While China has been a mainstay feature in many investors’ emerging-market portfolio allocations, the country’s struggles in 2021 have led to more than a few cases of second thoughts. But as difficult as it may be to let go, divesting exposure to Chinese equities might be a good decision on balance.
In a recent commentary, Regina Chi, VP and portfolio manager at AGF Investments, said that the MSCI China Index was down by about 14% for the year 2021 up to October 31 based on data from Factset. Over that same period, the MSCI Indonesia index advanced more than 4%, and MSCI India rose by more than 25%. EM indexes outside Asia did even better, including MSCI Argentina (up more than 34%) and MSCI Russia (up more than 37%).
“To many observers, China’s government turned more hardline in 2021 on a host of economic and political fronts,” Chi said. “[W]hen you add in trade tensions with the West, it is not surprising that some Westerners are wondering out loud whether China is uninvestable.”
While making clear that she did not share that view, Chi did acknowledge that Chinese equities might be taking up more than their fair share of allocations within broad EM benchmarks. Looking at the MSCI EM and FTSE EM indexes, Chinese stocks account for 34% and 36.5%, respectively. The large China allocation, she added, means 78% of the MSCI EM Index is in Asia stocks, while 14.3% and 7.3% are in EMEA and South America, respectively.
“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%,” she said. “An ex-China strategy would still be skewed towards Asia, but much less heavily so.”
Removing China could also free up room for investors to participate in more secular growth opportunities, such as e-commerce, which has yet to really hit its stride outside of China. The MSCI China index, Chi noted, is dominated by three big players in the internet and consumer retail/technology space, with those two sectors accounting for 45% of the index. But with rising regulatory scrutiny, Chinese e-commerce stocks might not have much headroom for growth.
In contrast, internet retailing makes up only 7% of total retail sales in India, while the MSCI EM index sans China would have only 6% placed in internet and consumer retail and technology companies.
“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,” Chi said. “On a broader level, this EM ex-China exercise demonstrates some of the pitfalls of lumping Emerging Markets together under one opportunity set.”