Article | The emerging market opportunities beyond China

Tom Bailey 08 March 2022

China is arguably the world’s biggest economy. [1] It leads the world in terms of manufacturing output, accounting for 20% of global production. [2] It is also the largest market for a plethora of products, from smartphones [3] to cars. [4] One area of breakneck growth has been Chinese e-commerce and technology firms. [5] Companies such as Tencent [6] or Alibaba [7] have gained multibillion dollar valuations, while Chinese founders such as Jack Ma have become household names. [8]

With China responsible for so much economic activity, it is no surprise that the country has come to represent an ever greater share of the MSCI Emerging Market Index, now representing over 30%. [9] Similarly, China accounts for around 35% of the FTSE Emerging index. [10] Meanwhile, the Emerging Markets Internet & Ecommerce Index (EMQQ) has roughly 60% in China. [11]

We believe many investors are looking for exposure to a fund tracking one of these emerging market indices, this creates a potential problem. While some investors may be keen to have gain such a high weighting towards China from these indices, for others this is less desirable.

There are several potential reasons for this. Some investors may fear further regulatory crackdowns on Chinese e-commerce. In 2021 several prominent Chinese tech companies faced increased scrutiny from Chinese regulators. [12] Others may have a bearish outlook on the Chinese economy. [13]

For many, however, it is simply a matter of portfolio diversification. Many investors may already have a high weighting towards China, with large Chinese companies being a favourite among active managed funds in recent years. [14] At the same time, with China’s economy and business landscape so varied and diverse, [15] many investors may wish to gain their China exposure separately. This may entail going for a more specialist, China focused fund.

Removing a country that dominates one region from an index or investment universe is common practice. Owing to the size of the UK market, many Europe funds remove UK holdings. [16] Likewise, the dominance of Japanese companies has seen many investors focus on Asia-Pacific ex-Japan. [17]

Therefore, to avoid doubling up on Chinese exposure, investors have been looking for funds that remove Chinese stocks. [18] One option is to use a fund that tracks the MSCI Emerging Market Ex-China index. As the name suggests, it removes China from the emerging markets index. This leaves the investor with around 24% in Taiwan,19% in South Korea, 19% in India and 6% in Brazil. [19]

However, one potential downside to this approach is the particular type of company it leaves the investor with heavy exposure to. Taking out China means that Taiwan Semiconductor Manufacturing (also known as TSMC) accounts for around 10% of the index. TSMC is one of the world’s largest companies, meaning investors may already have a relatively high exposure. But beyond this, it is questionable how much this can be considered a company providing exposure to emerging market growth. That is because TSMC derives the majority of its revenues from North America. [20] While based in an emerging market (Taiwan), from a revenue perspective, it can be argued that the company has more to do with developed markets.

Similarly, Samsung is the second largest holding, account for over 5%. Samsung revenue has more emerging market exposure, but a large chunk is still derived from North America and Europe. [21]

This matters for investors trying to tap into the emerging market growth story. When it comes to emerging markets, arguably the rise of the consumer is the real story. [22] As developing economies become richer, citizens of these countries have more money for consumption. The newly emerging middle class has rising disposable income and spends it on better food, clothing, education, and entertainment. [23] The companies offering these goods and services potentially stand to benefit. Indeed, McKinsey has called it the “the biggest growth opportunity in the history of capitalism.” [24]

Much of this demand will also come in the form of e-commerce. [25] However, rather than established Chinese or US firms benefiting from this, increasingly local entrepreneurs are doing so. As Brookings notes: “Homegrown entrepreneurs are uniquely positioned to take advantage of the digital trade opportunity.” [26]

With this in mind, a potentially preferable index for emerging market without China is the FMQQ Next Frontier Internet & Ecommerce Index. This index is the same as the EMQQ Emerging Markets Internet & Ecommerce Index but with China stripped out. It follows the same rules for selecting companies and hence captures the same e-Commerce growth, except that it excludes Chinese companies. [27] In our view, it gives investors the flexibility to deal with their China allocation separately while also gaining exposure to the boom of e-commerce in emerging and frontier markets.

When you invest in ETFs, your capital is at risk. 

Sign Up to Insights

Tell us how we can help