China seems to generate daily headlines with news of its economic woes. After three years of strict COVID policies, expectations of economic recovery in China were high this year but a weak second quarter, reports of record youth unemployment, and crisis after crisis in the real estate sector have dashed such hopes. Anemic economic growth combined with heightened trade complexities and increased diplomatic isolation have investors concerned.
Amid the intensified focus on China’s economic complications, the OUTcomes blog I wrote in February seems especially apropos right now. I’ll Take My Emerging Markets with China on the Side, Please discussed the best way for investors to take advantage of the growth opportunities in China - the world’s second-largest economy. And the country’s current challenges only underscore my initial point: Investors may benefit from having distinct China-only and emerging markets ex-China allocations. A separate allocation to China allows for the custom implementation required when investing in a complex market of this size, while an ex-China emerging markets equity allocation may provide better diversification, thus mitigating risks and capitalizing on opportunities for alpha.
Source: Factset, PGIM Quant
As of Sep 15, 2023
Data based on Factset estimates of the underlying securities, weighted to reflect index weight
The diversification effect becomes clear when we look at the percentage of revenue that comes from China across various indexes. Creating a discrete allocation to China, away from a standard EM index, reduces the exposure to revenues from China by nearly 80% for EM larger caps and by 44% for EM Small Caps. This puts the exposure in line with US large caps, all while harvesting the return potential and diversification from true emerging market securities.
For more on how investors can get the most from their emerging markets investments, check out the earlier OUTcomes blog here.