The Emerging Markets Beyond China

By Emerald Yau, Head of Equity Index Product Management, APAC | Catherine Yoshimoto, Director, Equity Index Product Management

Emerging markets: becoming the world’s powerhouse

The importance of emerging markets (“EM”) has been growing over the past decades. The 24 countries classified as Advanced Emerging and Secondary Emerging status by FTSE Russell^[1] today are contributing around 45% of the world’s total GDP (based on PPP terms; China alone contributes 18.8%), a substantial rise from just 26% in 1980^[2],

Chart 1: Emerging Markets’ Share of the World’s Total GDP Has Been on the Rise

China’s growth was the most significant. Its GDP alone is now larger than the aggregate GDP of the remaining 23 markets classified as Advanced Emerging and Secondary Emerging status by FTSE Russell.

Chart 2: China’s GDP Dwarfs the Rest of EM

China’s capital market has also grown significantly. China’s weight in the FTSE Emerging Index has skyrocketed from 5% as at the end of 2003, to 29% as at the end of 2023 (it reached 44% in 2020 before China equities soured). This figure is only expected to increase as China allows further access to its domestic capital market and as index providers increase China’s A Share inclusion factor (FTSE Russell currently applies a 25% inclusion factor on China A Shares in its global equity indices). Assuming a full inclusion of China A Shares at their free float and a recovery of China equity markets, China’s weight could exceed 50% of the FTSE Emerging Index.

China’s sheer GDP size and capital market size have given the country a prominent position among the EM complex, to the extent that when China sneezes, emerging markets catch a cold. This has been evidenced by the increased performance correlation between China and EM equity indices over the years.

Chart 3: Performance Correlation Between FTSE China Index and FTSE Emerging Index Has Increased to 0.9

China: unique risk and opportunity profile may justify a separate allocation from EM

Investors have long debated whether to split their EM allocations into China and EM ex-China strategies.

With the rising dominance of China in EM indices, EM investors will inevitably take on a larger exposure in China. However, it is evident that China presents unique idiosyncratic risks and rewards. On the one hand, investors worry about geopolitical tension, sanctioned companies, and domestic regulatory risks. On the other hand, China, as the world’s second-largest economy offers interesting investment opportunities fueled by innovation, with notable advancements in e-commerce, the digital economy, electric vehicles, clean power, and biotechnology.

The idiosyncratic risks in recent years have impacted China’s stock markets, causing a sharp decoupling of performance between China and EM ex China, particularly over the last 3 years. China’s growing weight and its unique risk and opportunity profiles have fueled the need for investors to better manage the risk that comes with an allocation to China. For these investors, this has necessitated the separation of China from the rest of the emerging markets investment opportunity set.

Emerging ex China: a sufficiently large market with diverse opportunities

Emerging markets have always been diverse. These countries are at various stages of economic growth and structural development, and they face diverse demographics and political agendas. As such, each emerging market can offer a different set of investment opportunities.

For example, India’s technology companies are thriving while consumption and healthcare may benefit from a rise in per-capita income. Taiwan’s position as a leader in semiconductor manufacturing may advance further amidst the rising AI trend. ASEAN, India, and Mexico stand to gain from supply chain relocation and diversification. Saudi Arabia and Kuwait offer exposure to large regional banks which may be used to add a defensive component to the opportunity set. Brazil offers exposure to one of the world’s largest oil and gas companies and plentiful dividend opportunities.

Over the years, the EM proposition beyond China has witnessed a shift away from Telecommunications, Energy, and Basic Materials, towards Technology, Financials, and Health Care. These myriad opportunities might have been suppressed in a traditional EM index (i.e. with China included), given China’s relative weight.

Chart 4: Shift in Industry Exposure Over Time in FTSE Emerging Ex China Index

In the FTSE Emerging Index, which includes China, 5 of the top 10 constituents were Chinese companies as of the end of 2023. However, in an EM universe beyond China, other opportunities can gain bigger seats in the index and can enjoy more of a spotlight, providing a source of diverse, long-term growth in an investor’s portfolio.

To this end, FTSE Russell provides index solutions to clients who wish to manage China as a separate allocation to EM exposure.

Chart 5: FTSE Russell Index Solutions

Click to enlarge

Source: FTSE Russell, data as of December 31, 2023.Past performance is no guarantee of future results. Please see the end of this presentation for important legal disclosures.

Chart 6: Top 10 Constituents in FTSE Emerging Ex China Index

Click to enlarge

Source: FTSE Russell, data as of December 31, 2023.Past performance is no guarantee of future results. Please see the end of this presentation for important legal disclosures.

The way investors look at their EM strategy may now be at an inflection point.

As China continues to gain dominance in EM indices, investors may increasingly prefer to carve out their China investment strategy to have better control over its unique risk and reward characteristics. This is not unusual in the ever-changing investment world – think about Japan as a standalone investment in an Asia ex Japan strategy, or the US as a standalone investment from a developed markets ex US strategy.

1. Equity Country Classification | LSEG

2. Source: International Monetary Fund, World Economic Outlook Database, October 2023. Based on “Gross domestic product based on purchasing-power-parity (PPP) share of world total” datapoints for the 24 countries classified as Advanced Emerging and Secondary Emerging status by FTSE Russell as of 31 December 2023.

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