Investors are increasingly favoring other emerging countries over China’s markets due to geopolitical and growth risks. This shift is reflected in the significant increase in assets of emerging market mutual funds and ETFs that exclude China. The aversion to China has grown stronger this year due to its economic struggles, lack of robust policy response, and tensions with the US. Some investors are redirecting their money to countries that benefit from China’s economic pain, such as Mexico, India, Vietnam, and other locations in global manufacturing supply chains. Others are moving to markets with better growth prospects, like Brazil.
According to Malcolm Dorson, a senior portfolio manager at Global X, China’s declining export dominance is creating opportunities for other emerging market countries to fill the gap. This trend of capital flows could continue for the next decade. Data from Refinitiv shows that China-focused mutual funds experienced a net outflow in the second quarter of this year, while EM ex-China mutual funds received nearly $1 billion in inflows. The iShares MSCI Emerging Markets ex-China ETF attracted a record $1 billion net inflow in the first half of 2023.
These ETFs and funds also offer alternatives to tracking the EM MSCI index, which is heavily influenced by China. China is the major country that investors are most concerned about in the emerging market. John Lau, a portfolio manager at SEI, explains that Latin American markets, tech-driven companies in South Korea and Taiwan, and supply chain changes offer better opportunities than China.
Foreign buying of emerging market Asia ex-China equities has exceeded inflows into mainland Chinese equities for the first time since 2017, according to data from Goldman Sachs. The top 10 China-focused mutual funds have seen a significant decrease in size, and fund managers and advisers are struggling to attract investment into China-focused products. Investors are turning to ex-China exposures within Asia, such as Japan.
China’s CSI 300 index has remained flat for the year, while Japan’s Nikkei index is up 25% and the S&P 500 nearly 19%. Investors have become more cautious after the US expanded its restrictions on investments in Chinese companies. The restrictions, along with concerns about investment limits and sanctions, have made portfolio investors wary.
China’s recent pledge to step up stimulus measures to support its economy provides some hope for investors, but it’s too early to determine the impact on foreign money inflows. In addition to financial risks, western institutional investors are also concerned about reputational risks associated with investing in China. It is becoming increasingly difficult to justify China investments to compliance departments and management.
The Biden administration is working on an executive order to restrict outbound US investments to China, and Canada has held a parliamentary hearing to examine domestic pensions’ relationship with China. Wong Kok Hoi, the chief investment officer of APS Asset Management, believes that US, Canadian, and European investors are exiting China due to political pressure, which has led to an “investment war” following the trade and tech wars.
In conclusion, global investors are shifting their focus away from China’s markets towards other emerging countries due to various risks and concerns. This trend is reflected in the increase in assets of EM mutual funds and ETFs that exclude China. The decline in China’s export dominance and the opportunities in other emerging markets are driving this shift. However, China’s recent stimulus measures and the potential impact of political pressure on investments remain uncertain factors.
