Investors Shun China in Emerging Markets, Embrace 'Ex China' Funds

A growing wave of investors are turning their backs on China within the emerging markets landscape, opting for funds that exclude the world's second-largest economy, reports the Financial Times. This shift, fueled by concerns over escalating geopolitical tensions and the potential for sanctions, marks a significant change in emerging market investing.

While Chinese stocks have enjoyed a recent rally following Beijing's stimulus measures, investors remain wary. They view China as too large and risky to manage alongside other developing economies like India, leading to a surge in demand for "ex China" emerging market funds.

Franklin Templeton, the latest to join the trend, launched a new "ex China" emerging markets vehicle this week, adding to a growing class of funds that have seen their assets swell by 75% this year, reaching over $26 billion, according to Morningstar data.

“When investors are keen to avoid a certain sector or region, the industry is happy to oblige,” said Michael Field, equity strategist at Morningstar, to the Financial Times.

The shift is driven by concerns about China's influence, its volatile stock market, and the potential for sanctions. Investors, particularly in the US, are increasingly hesitant to hold Chinese equities due to national security concerns and the potential for further restrictions on investment in key sectors like technology.

This trend is exemplified by pension funds in Missouri and Florida, which have divested from Chinese stocks citing national security risks and "foreign adversaries" like China.

The move towards "ex China" funds has created a new asset class, allowing investors to focus on economies like India, Taiwan, and others, offering potentially higher returns.

"China is a different type of market — it does have those idiosyncratic risks, and perhaps needs to be looked at by specialists," said Naomi Waistell, a portfolio manager at Polar Capital, to the Financial Times.

This shift highlights a growing divergence in sentiment between US and European investors. While US investors are more wary of China, European investors tend to be more pragmatic and see China as a necessary part of a diversified portfolio.

The Financial Times noted that some investors question whether simply avoiding China alone can mitigate the political risks associated with emerging markets: risks also exist in companies in developed economies that have significant exposure to China. This interconnectedness highlights the challenge for investors seeking to completely disentangle themselves from political risks.