Could Emerging Markets Work Without China?

VIDEO: Rayliant is taking China out of its emerging market fund to offer more diversification for investors

Kate Lin 27 October, 2023 | 11:35AM
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Kate Lin: Welcome to Morningstar. Is it fair to call the global economic giants that is China an emerging market? That is a question that has come up many times in the recent past.

For Jason Hsu, founder and CIO at Rayliant Global Advisors, the answer is no. He’s here to tell us why his funds have separated China from their emerging market mandate.

Jason, thank you so much for being here. To start, how has China’s weightage and influence in an EM portfolio changed over the years?

Jason Hsu: Well, in the very beginning, China was a relatively small allocation in the broader EM. But over time as China’s GDP grew at a near double-digit pace, it’s become almost at times 50% of the EM basket. What that means is if China has a good year, EM has a great year, but if China has a bad year, it drags EM down as well.

So you can think of China inside EM as almost like the US inside the global developed market basket. You have to take the US out of DM (developed markets). For the same reason now, you have to take China out of EM just so that there’s less concentration within one single country and as a result would improve asset allocation efficiency.

Lin: And you have seen recently investors starting to split their EM portfolios into China and EM ex-China. Does it have anything to do with the recent sluggish returns from the Chinese markets and how should we read this trend?

Hsu: Well, I think part of it is absolutely China has been probably one of the worst performing markets within EM and that’s obviously frustrated a lot of people, who I would say, five years ago were expecting great things from China. But I think it’s probably much more with the ESG angle, in the sense that I think there’s a lot of negative publicity when it comes to China, the fact that it maybe is often on the other end of a trade dispute or geopolitical dispute with the US. And obviously, the US is the biggest investment market from a pension, from a wealth perspective. So there’s just a lot of optics reasons, a lot of sort of emotional reasons that have I think caused many investors to want to have a reduced weight to China or perhaps even no weight to China.

And again, further, I would say accentuating the case to take China out of the EM so that people can have that flexibility, right? Do you want China? Do you not want China? More or less? You take it out of the basket all of a sudden that’s a decision that we can leave to different financial fiduciaries, and different investment advisers to handle.

Lin: Yes. And your firm’s active ETF investing in emerging markets is doing exactly that, going ex-China from this month. What is behind this decision and how can investors benefit from it?

Hsu: So Rayliant Global Advisors is very much a contrarian. I would say, we’re much more value oriented. So in some ways, we like China right now, because it’s done so poorly. The fundamental is actually still there. The long-term thesis is still there. So from a contrarian and value perspective, we like it.

But we still think it’s the right reason to take China out of EM. So we have an EM ex-China product because we do believe from an asset allocation perspective, it gives investors freedom. It allows different investors and we have investors, some who are contrarians like us, who like China, and some who really are concerned about China and may believe China is actually uninvestable for the long run. And so we want to give them that flexibility.

But you know the amazing thing is EM exiting out China, you still have phenomenal opportunities, right. You still got India in there, you got South Korea, you got Taiwan, you got a lot of Africa and the Middle East emerging and coming online. And those are wonderful opportunities that again I think once you ex them out of China they can then start to express their heterogeneity and really come into the portfolio as a diversifier and really a different source of long-term growth. And so we obviously are very enthusiastic about the EM that is outside of China and you can say maybe friend-shoring will help. But really broadly just a diversification benefit from these diverse growth factors I think is reason enough for people to be focused on EM without China in it.

Lin: Wonderful. Thank you so much for joining us today, Jason. For Morningstar, I’m Kate Lin.

Independent Analysis. Expert Opionions. Timely Commentary.

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Kate Lin  is an Editor for Morningstar Asia, and is based in Hong Kong

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