China has emerged as a formidable economic force, attracting global interest. As the world's second-largest equity market, China distinguishes itself from other emerging markets. Our research shows that factors perform effectively across EM, EM ex-China, and China, allowing for compelling portfolio performance in each area.
Remarkable growth leads to changing opportunities
With an average GDP growth rate of 9% from 1980 to 2021, China's economic expansion is unparalleled. This growing dominance is reshaping diversification strategies in emerging markets. Despite its surge in the MSCI EM Index from 7% in 2001 to 30% in June 2023, its correlation with the index has not risen proportionally. This is caused by China’s increasing disparity with other markets. This divergence is underscored by the last year’s higher net foreign inflows into Asian emerging markets, excluding China, compared to mainland China.
Investors in emerging markets seek diversification and alpha-driven opportunities. However, China's sheer size can overwhelm other attractive emerging market countries. Our bottom-up stock selection model effectively captures alpha across these diversified landscapes. Strong factor premiums in EM, EM ex-China, and China indicate that all three regions offer compelling investment opportunities.
Performance trends are generally consistent across the three regions, though some deviations exist due to country-specific factors. The correlation of outperformance between EM and EM ex-China is above 80%, while the correlation between EM ex-China and China is below 30%, suggesting diversification benefits. For our Enhanced Indexing and Active Quant strategies, we observe a consistent range of outperformance over the last five years and since 2010.
Conclusion
China's increasing influence and decreasing correlation with other emerging markets could make a case for separate allocations. Our Core Quant strategies aim to effectively capture alpha across these diversified landscapes. Investors may not need to choose between EM and EM ex-China, as custom weighting options allow for a nuanced exposure.
