Tap emerging market growth, while avoiding specific China risks

WE BELIEVE China is no longer an attractive market for investment. China’s challenges run deep, stemming from the economic malaise and persistent long-term structural issues, such as the embrace of a top-down state-controlled economic growth model and the shifting geopolitics.

Investing in China now carries considerable risks, including the uncertainty of shifting geopolitics, regulatory changes, and economic instability. The sentiment surrounding Chinese tech giants, which are heavyweights in major indices, remains negative due to a slowing economy and subdued private consumption.

However, when we shift the focus away from China, we see more promising long-term growth prospects among its emerging market (EM) counterparts. South Korea, for example, is a standout. The country is well-positioned to harness its technological capabilities and innovation. Coupled with a highly educated and skilled workforce, it can potentially become the technology powerhouse in Asia. The country also stands to benefit from the imminent rebound of the semiconductor cycle, owing to the pivotal roles played by major corporations like Samsung and SK Hynix in the global semiconductor industry.

In India, we observe the potential for growth through the “China Plus One” strategy, as the country aims to position itself as an alternative manufacturing hub to China. This opens doors for growth in areas such as manufacturing and assembly of goods and exports, which is set to be supported by a young and growing population.

Meanwhile, Taiwan is reputedly the world’s semiconductor powerhouse, with Taiwan Semiconductor Manufacturing Company (TSMC) being the No 1 go-to foundry for cutting-edge chips. The long-term structural factors driving semiconductor demand remain robust, supported by the generative artificial intelligence (AI) craze and ongoing technological innovations.

Indices tracking the performance of large and mid-capitalisation EM equities excluding China, such as the MSCI Emerging Markets ex-China Index, have consistently shown stronger performance over extended periods. This highlights the traditional over-reliance on China in the EM investable universe and the concentration risk faced by investors. To put this into perspective, China makes up a sizeable 30 per cent of the MSCI Emerging Markets Index.

Apart from the absence of China as a detracting factor, the robust performance of EM ex-China can be attributed to the resilience of markets such as India, Taiwan and South Korea, which are assigned greater weighting compared to traditional EM indices. These three markets collectively comprise around 60 per cent of the MSCI Emerging Markets ex-China Index, much higher than their 40 per cent share in the MSCI Emerging Markets Index (as at end-September 2023).

In terms of sectors, information technology has a 26 per cent weighting in the MSCI Emerging Markets ex-China Index. Leading semiconductor industry players such as TSMC, Samsung and SK Hynix dominate this segment. The second-largest sector is financials, with a 25 per cent weighting. The index provides diversified exposure to banks across the EM region, including major Indian private-sector banks such as ICICI Bank and HDFC Bank.

In conclusion, we think investors should exercise caution by limiting their exposure to China within their portfolios. This can be achieved by embracing EM ex-China strategies through passive exchange traded funds (ETFs), such as the iShares MSCI Emerging Markets ex-China ETF.

By opting for this strategy, investors would not only mitigate China-specific risks, but also potentially benefit from greater long-term opportunities in other major EM markets.

The world is set to become less reliant on China, given the depth of challenges faced by the country. We believe investing in EM ex-China is poised to emerge as a winning strategy going forward.

The writer is an assistant manager with the research and portfolio management team at FSMOne.com, the B2C division of iFast Financial. The latter is a subsidiary of mainboard-listed iFast Corporation.