Investors may ditch China, but I’m keeping some skin in the game

The idea of investing in emerging markets without China is a bit like baking a loaf of bread without adding any yeast. Missing out such a key ingredient would be a bold call.
Yet this is precisely what several fund companies are starting to do. The asset manager Abrdn is the latest to relaunch an emerging markets fund — Emerging Markets Sustainable Equity — excluding the biggest country in the region. Why?
The driving force for the performance of emerging markets has been their fast-growing economies, propelled by young populations and an increasingly wealthy middle class. China has been the powerhouse behind much of this growth but has started to lag upstarts such as India and South Korea.
Two decades ago Chinese firms accounted for about 5 per cent of the value of the MSCI emerging markets index. Years of strong growth took its share to about 25 per cent today, when about half the 1,328 companies in the index are Chinese.
But bigger does not always mean better. The index is up 21 per cent over the past year and 5 per cent over five years. China makes up 24 per cent, India 20 per cent, Taiwan 19 per cent and Korea 12 per cent.
The MSCI emerging markets excluding China index, as the name suggests, invests in the same region but screens out Chinese stocks. The most dominant country in the index is India at 26 per cent followed by Taiwan at 25 per cent, Korea at 15 per cent and Brazil 6 per cent. This index is up 27 per cent over the past year and 9 per cent over five years.
India, with its young population and political reforms, has performed well. It is the third largest consumer market in the world behind the US and China and remains the go-to for companies looking to outsource their IT needs thanks to its low cost but skilled, English-speaking workforce.
Meanwhile, Taiwan and Korea are home to some of the biggest tech stocks in the world. Taiwan Semiconductor is the computer chip manufacturer of choice for companies including Apple, and the Korean electronics company Samsung remains a global leader.
With poor performance, an uncertain economic outlook and concerns about governance and sustainability, perhaps it is not surprising that some investors are now opting to avoid China, especially when its peers are so appealing.
This is not an entirely new phenomenon. Japan, for example, is routinely excluded from general Asia funds. The thinking is that as a country’s economy and stock market matures, its profile starts to look very different from its peers so bucketing it in with them starts to make less sense.
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One could argue that a country with a GDP of $4 trillion does not really fit the definition of an emerging market. But arguably this lack of cohesion is true across the board for emerging markets countries anyway, regardless of their size. Do South Africa, Brazil and Taiwan really have much in common, other than not being deemed to be of “developed” status?
Still, there are other reasons that investors may want to shut China out of their emerging markets exposure. Trade tensions persist between China and the US, and Trump has threatened to increase tariffs on Chinese imports to 60 per cent if he wins November’s election.
Concerns remain about whether China will invade its neighbour Taiwan, and its property market is widely regarded as being in crisis. Add to this an ageing population, youth unemployment of 19 per cent and the fact that many multinational companies are diverting their manufacturing away from China and closer to home.
But make no mistake, excluding China from your portfolio is a huge call and should not be done lightly. The country still accounts for 19 per cent of global GDP and 16 per cent of all listed companies.
There are reasons to be cheerful too. Economic growth at the start of the year beat expectations and this week the Chinese government unveiled an aggressive stimulus package designed to drive it further forward.
Investors who want exposure to emerging markets have a few options — the easiest of which is just to stick with the tried and tested broad index, including China, using either a tracker fund or a general Asia fund.
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Alternatively you could hold an “ex China” fund that has no Chinese stocks, alongside a specific China fund, so that you are more in control of the size of your allocation.
Or you could leave the decision to a professional. The Jupiter Asian Income fund, for example, is allowed to invest in China but its manager, Jason Pidcock, currently has no investments there. Perhaps he will again in the future when he sees an opportunity.
My exposure to China is fairly muted. It comes through the Pacific Assets investment trust, which has 7 per cent of its portfolio in the country and that feels enough for me. China is still the second largest economy and home to some of the biggest companies, including the e-commerce company Alibaba, the conglomerate Tencent and the insurer Ping An. To rule it out entirely would surely be a mistake.