Analysis indicates that global investors are favoring emerging markets over China's markets: ICCBizNews

A portion of the funds is being redirected towards markets that directly benefit from China's economic challenges. Countries like Mexico, India, and Vietnam, among others, are gaining prominence as they become essential players in the global manufacturing supply chains, replacing China.

According to Reuters analysis, global investors are increasingly opting to avoid China's markets in favor of other emerging economies. These countries either benefit from the geopolitical and growth risks affecting China, or they are situated far away from those risks. As a result, there has been a significant surge in the assets of emerging market (EM) mutual funds and exchange-traded funds (ETFs) that exclude China. Investors from the United States and Europe are becoming more cautious about their exposure to the Asian giant and are seeking alternative opportunities in emerging markets.

This year has seen a growing aversion among investors towards China, mainly due to the economy's sluggish post-COVID recovery, disappointment over the lack of a robust policy response, and renewed tensions with the United States concerning trade, technology, and geopolitics. Consequently, some investors are diverting their funds into markets that directly benefit from China's economic challenges. Countries like Mexico, India, and Vietnam are stepping in to replace China in global manufacturing supply chains. Additionally, other investors are simply seeking better growth prospects in markets like Brazil.

Malcolm Dorson, a senior portfolio manager at ETF manager Global X based in New York, pointed out that China's export dominance is waning, which opens up opportunities for other emerging market countries to step in and fill the gap. He believes that the necessary adjustments in global supply chains could lead to significant capital flows into these alternative markets over the next decade.

According to Refinitiv data, China-focused mutual funds experienced a net outflow of $674 million in the second quarter of this year. Conversely, nearly $1 billion was invested in mutual funds focused on emerging markets excluding China. The iShares MSCI Emerging Markets ex-China ETF, which is the largest ETF of its kind and holds major companies in Taiwan, South Korea, and India, saw a record net inflow of $1 billion in the first half of 2023.

Given that China represents almost a third of the EM MSCI index, these ETFs and funds provide alternative options for tracking the index. John Lau, the portfolio manager for Asia Pacific and emerging market equities at SEI, mentioned that China is the primary concern for investors within the EM space. Instead, they are finding more favorable growth prospects and valuations in Latin American markets, as well as tech-driven tailwinds for companies in South Korea and Taiwan. Furthermore, the changes in supply chains are creating better investment opportunities compared to China.

As of mid-July, data from Goldman Sachs revealed that foreign investors had purchased $39 billion worth of emerging market Asia ex-China equities over the past 12 months. This marked the first time since 2017 that such buying exceeded the inflows into mainland Chinese equities via the Stock Connect scheme.

CHINA'S UNPOPULARITY

The combined size of the top 10 China-focused mutual funds, tracked by Morningstar, has decreased by over 40% from its peak in 2021. Notably, the UBS China Opportunity Equity Fund, a well-known fund, saw its assets shrink to $4.5 billion by the end of June, a mere fourth of the levels seen in January 2021. Singapore sovereign wealth fund GIC's CIO, Jeffrey Jaensubhakij, stated that they have gradually redirected their capital to sectors and countries that benefit from shifts in the global supply chain. A substantial portion of these investments has moved away from China and towards countries like Mexico, India, Indonesia, and Vietnam.

Fund managers and advisers are facing challenges in attracting investments into China-focused products. Benjamin Low, a senior investment director at Cambridge Associates, a Boston-based advisory firm, mentioned that there has been a notable lack of interest in China-focused mandates over the past six to twelve months. Instead, some of his clients are exploring opportunities in ex-China exposures within Asia, such as Japan.

When comparing the performance of major indices, China's CSI 300 index has remained relatively flat for the year, whereas Japan's Nikkei index has surged by 25%, and the S&P 500 has seen a nearly 19% increase. Investors who were already cautious after the Trump administration restricted U.S. investments in Chinese military companies have become even more hesitant following President Joe Biden's government's decision to expand the list of banned sectors to include chips and quantum computing.

Portfolio investors are exercising caution to avoid running afoul of investment limits or getting caught in sanctions, as several restrictions apply to exports and venture capital.

According to a business development manager at a Hong Kong-based hedge fund, who is not authorized to speak to the media, the current situation is even more challenging than last year. Unlike before when investors had some optimism due to the prospect of reopening, they now face greater uncertainty.

Despite managing to generate profits in the first half of the year amidst the difficult market conditions, the hedge fund has been facing difficulties in attracting new investments from foreign investors in recent months.

China's recent commitment to increase stimulus measures to bolster the economy offers some hope for investors, but it remains unclear how it will impact foreign capital inflows at this early stage.

Apart from financial risks, western institutional investors are becoming increasingly concerned about the rising reputational risks associated with investing in China. Portfolio managers find it challenging to justify China investments, even when presenting the case to their internal compliance departments and management. To illustrate, Canada conducted a parliamentary hearing in May to scrutinize the relationship between several domestic pensions and China. Additionally, the Biden administration is in the process of developing an executive order to restrict outbound U.S. investments to China.

Wong Kok Hoi, the chief investment officer of APS Asset Management, highlights that U.S., Canadian, and some European investors are withdrawing from China due to political pressure. He notes that on the surface, it appears as if the U.S. has initiated an investment war, following the trade war and tech war that have already taken place.