This is how you can unlock the growth potential in emerging markets without China-specific risks

• For investors looking to limit their exposure to China within their portfolios, the pain point lies in the fact that China typically occupies a substantial portion of traditional regional indices.

• The good news is that more “ex-China” products have hit the market in recent times. One can consider the iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC).

• The exclusion of China means that markets like India, Taiwan, and South Korea are given larger weights compared to traditional EM ETFs. The largest holdings include TSMC, Samsung, and SK Hynix.

• Investing in EM ex China has its advantages, such as the reduction of exposure to China-specific risks. EM ex China strategies like the EMXC ETF have also delivered stronger returns over the longer term.

• Looking beyond China, we see better long-term growth opportunities in other major EM markets especially South Korea.

We have consistently reiterated our view that China is no longer an attractive market for investment. China’s challenges run deep, stemming from the economic malaise and persistent long-term structural issues, such as the embrace of a top-down state-controlled economic growth model and the shifting geopolitics.

(Related article: Is China’s stock market finally too cheap to be ignored?)

As such, we think investors should exercise caution by limiting their exposure to China within their portfolios. The pain point, however, lies in the fact that China typically occupies a substantial portion of traditional regional indices due to the sheer size of its economy and stock market. For some perspective, consider that within the emerging markets (EM) region, China constitutes a sizable 30% of the MSCI Emerging Markets Index.

But fear not! In recent times, more “ex-China” products have hit the market. On our platform, investors can gain access to a selection of “ex-China” ETFs.

Here are the range of EM ex China ETFs on our platform

For investors seeking passive instruments, our platform currently offers four passive EM ex China ETFs (Table 1). We examine them across some metrics below.

Assets under management (AUM): The largest EM ex China ETF is the iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC), boasting an impressive USD 5.22 billion in AUM. In comparison, its peers have AUMs ranging from USD 31.67 million to USD 373.46 million, making EMXC more than 10 times larger. Generally, a higher AUM correlates with lower expense ratios and higher liquidity.

Average daily volume (ADV): Unsurprisingly, EMXC also leads in ADV, with over 806 million shares traded daily. This indicates its high liquidity, allowing investors to enter and exit positions swiftly with minimal price impact.

Expense ratio: Among these ETFs, the Columbia EM Core ex China ETF (NYSE:XCEM) stands out with the lowest expense ratio of just 0.16%. A lower expense ratio is desirable as lower costs can potentially lead to better long-term performance. While EMXC is not the cheapest ETF, with an expense ratio of 0.25%, it remains a reasonably cost-effective option. Its higher liquidity could also make up for this slightly higher cost.

In addition to these metrics, we also note that there are some differences in the ETFs. For example, EMXC and the KraneShares MSCI Emerging Markets ex China Index ETF (NYSE:KEMX) track the same index (MSCI Emerging Markets ex China Index) but hold different numbers of securities. The latter likely employs a sampling methodology, holding a subset of the index's constituents to replicate its performance.

Table 1: Comparison of passive EM ex China ETF

ETF Name	AUM (USD Million)	ADV (‘000)	Expense Ratio	Number of Holdings
iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC)	5,219.97	806,924	0.25%	666
Columbia EM Core ex China ETF (NYSE:XCEM)	373.46	115,410	0.16%	304
Strive Emerging Markets Ex-China ETF (NYSE:STXE)	152.74	29,495	0.32%	698
KraneShares MSCI Emerging Markets ex China Index ETF (NYSE:KEMX)	31.57	6,795	0.23%	316
Source: Bloomberg Finance L.P, iFAST Compilations Data as of 31 August 2023

Introducing the iShares MSCI Emerging Markets ex China ETF

Based on our in-house ETF selection methodology, we consider the iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC) as the best-in-class EM ex China ETF. EMXC aims to replicate the investment results of the MSCI Emerging Markets ex China Index which consists of large- and mid-capitalisation EM equities, excluding China. As of 31 August 2023, the ETF holds a diversified portfolio of 666 securities.

The exclusion of China means that markets like India, Taiwan, and South Korea feature more prominently compared to traditional EM ETFs (Figure 1). India, Taiwan, and South Korea collectively take up around 60% of EMXC. The ETF also holds markets from Latin America and Europe, the Middle East, and Africa such as Brazil (7%) and Saudi Arabia (6%).

Figure 1: Markets like Taiwan, India, and South Korea have a stage to shine

On a sectoral level, EMXC has a substantial weightage of 27% in information technology (IT), higher than traditional EM ETFs (Figure 2). This is mainly because China’s tech giants, such as Tencent (HKEX:700), Alibaba (HKEX:9988), and Meituan (HKEX:3690), are classified in the consumer discretionary or communication sectors. Within the IT sector, EMXC’s largest holdings are semiconductor plays, such as TSMC (NYSE:TSM), Samsung, and SK Hynix.

Meanwhile, the second-largest sector is financials, with a sizable weightage of 25%. The ETF holds a diversified exposure to banks in the EM region; notable examples include major Indian private-sector banks like ICICI Bank and HDFC Bank, as well as Al Rajhi Bank, which is the world’s largest Islamic bank headquartered in Saudi Arabia.

Figure 2: The largest sector is IT

Table 2: Top 10 holdings of EMXC

Name	Sector	Market	Weight
TSMC	Information Technology	Taiwan	9.02%
Samsung Electronics	Information Technology	South Korea	5.14%
Reliance Industries	Energy	India	1.88%
ICICI Bank	Financials	India	1.26%
Infosys	Information Technology	India	1.22%
HDFC Bank	Financials	India	1.13%
SK Hynix	Information Technology	South Korea	1.07%
Vale S.A.	Materials	Brazil	0.95%
Hon Hai Precision Industry	Information Technology	Taiwan	0.89%
Al Rajhi Bank	Financials	Saudi Arabia	0.80%
Total	-	-	23.36%
Source: iShares, iFAST Compilations Data as of 31 August 2023

Benefits of investing in EM ex China

Investing in EM ex China offers distinct advantages.

Most notably, investors can reduce their exposure to China-specific risks including the shifting geopolitics, regulatory changes, and economic uncertainties. Sentiment surrounding Chinese tech giants, which are heavyweights in traditional EM indices, has remained negative due to a slowing economic recovery and weak consumption. China’s underperformance has become a major detractor in EM, underscoring the traditional overreliance on China in the EM investable universe and the concentration risk faced by investors.

Meanwhile, EM ex China strategies like the EMXC ETF have demonstrated better performance over the longer term (Figure 3). Apart from the absence of China as a detracting factor, the robust performance of EMXC has been lifted by resilient markets like India, Taiwan, and South Korea which hold substantial weights in the portfolio.

Figure 3: EM ex China has outperformed

Furthermore, when we shift the focus away from China, we see better long-term growth opportunities in other major EM markets, with South Korea emerging as a standout. South Korea is poised to leverage on its technological capabilities and innovation. This, coupled with a highly educated and skilled workforce, positions the country to become the technology powerhouse in Asia. South Korea also stands to benefit from the imminent rebound of the semiconductor cycle, owing to the pivotal roles played by major corporations like Samsung and SK Hynix in the global semiconductor industry.

(Related article: The Shifting Geopolitics and The New Asian Tigers)

Turning the attention to India, we find that it may benefit from the “China Plus One” strategy as it seeks to position itself as an alternative manufacturing hub to China. This opens doors for growth in areas such as manufacturing, assembly of goods and exports, which is set to be bolstered by a young and growing population.

Meanwhile, Taiwan boasts its status as the world’s semiconductor powerhouse, with TSMC being the number one go-to foundry for cutting-edge chips. Moreover, the long-term structural factors driving semiconductor demand remain robust, supported by the generative artificial intelligence (AI) craze and ongoing technological innovations.

Final thoughts

For those looking to reduce their exposure to China within their portfolios, we believe the iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC) stands out among the passive investment instruments, in terms of its liquidity and expense ratio.

China typically commands a significant share of traditional regional indices. The exclusion of China means greater weights are assigned to markets like India, Taiwan, and South Korea when compared to traditional EM ETFs. On a security level, EMXC’s top holdings include leaders in the semiconductor industry such as TSMC, Samsung, and SK Hynix.

By opting for strategies like the EMXC ETF, investors not only can mitigate China-specific risks, but also potentially benefit from greater long-term opportunities. Looking beyond China, we find compelling growth prospects in other major EM markets with South Korea standing out as a prime example.

All in all, as the world grows to become less reliant on China whose challenges run deep, we believe investing in EM ex China will be a winning strategy moving forward.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.