It happened to the UK. It happened to Japan. Countries which were viewed as pivotal but very different to their near neighbours paved the way to investment indices which covered Europe ex-UK and Asia Pacific ex-Japan. Does China face the same scenario in the emerging world, or is this bordering on ‘omission impossible’ territory?
‘The case for it varies depending on what angle you take,’ said Polina Kurdyavko, head of emerging markets at BlueBay Asset Management. ‘A lot of the EM indices have moved to include more of China – not just sovereigns but corporates – but there are China-specific indices that have grown as well.’
Kurdyavko, who is named across a host of emerging debt strategies at the London-based group, said the international buyer base for Chinese debt has matured and increased in sophistication in recent years. Meanwhile, the Chinese government itself has moved to clarify and solidify its onshore bond offerings for foreign buyers.
‘A lot of the EM indices have moved to include more of China – not just sovereigns but corporates – but there are China-specific indices that have grown as well’
Polina Kurdyavko, BlueBay AM
Issues such as property developer Evergrande’s debt crisis may have raised concerns, but Kurdyavko believes there is still plenty of appetite for China’s growth story. This is especially the case as the country becomes more integrated into the surrounding region through its One Belt One Road initiative, along with increased exposure in emerging market bond indices.
If anything, improved market access has made more progress on the equity side, which has moved from quoted systems – such as QFII and RQFII – to more direct investment through A-shares. For example, in 2019, index giant MSCI bulked up the A-shares allocation in its broad emerging market (EM) index from 5% to 20% to reflect the increasing opportunities.
At that time, the company said: ‘In particular, the growing size of China within emerging markets portfolios raises a question for global investors whether to establish a dedicated China allocation or continue to incorporate China as a component of their emerging market allocation.
‘MSCI is committed to providing a comprehensive suite of innovative product offerings and research-based solutions to help institutional investors navigate the opportunities and challenges.’
As Chinese companies become more internationalised, with the likes of Alibaba and Tencent closing in on becoming household names in the West, the case for Chinese corporates to be treated differently from the remaining EM bucket of businesses intensifies.
China increasingly embedded in global economy
Omotunde Lawal, head of EM corporate debt at Barings, believes China has become so interwoven with the emerging story, as well as the broader global growth story, that it can be hard to decide whether to roll it completely into your EM investments or treat it as a separate category.
‘It’s hard to decouple China from the rest of the world but it is simplistic to view the EM as a China beta play,’ she said. ‘China is the second largest economy in the world, I would say it is on course to overtake the US.
‘If you think about it in terms of exports around the world, but also in terms of soft power that China has, you can see that in areas as far afield as Sri Lanka or most of Africa, which has accepted funding from China. So they will have a lot of power caught up in the world, especially as the US has been retracting its own dominance on the global stage.’
Lawal, who is a strong advocate for ‘doing your homework’ on China, especially in light of the Evergrande debt scandal, said reform is taking place which has led to regulatory crackdowns but also a shift in where policy priorities lie, such as around antitrust initiatives.
‘It’s hard to decouple China from the rest of the world but it is simplistic to view the EM as a China beta play’
Omotunde Lawal, Barings
That said, there is a diversification argument which would mean there is a case for keeping China as part of your broader EM allocation, she said. ‘If China sneezes, the rest of the world catches a cold, but that’s not to say the whole world is a China beta play.
‘Everybody has links to China but to varying degrees. The more commodity-linked economies, such as Brazil or Peru or Chile, will have a higher China beta due to trade. But some, such as Turkey and South Africa, have generally less China exposure. It’s varied but you can make an argument that perhaps the EU is more closely tied than some other EM nations.’
Pierre Bonart, head of multi-management at Edmond de Rothschild, believes a question related to whether you should go down the EM ex-China route is whether China is an EM any more at all. ‘If you look at GDP growth, then maybe yes, it is an EM, but if you look at the level of services or its IT stocks, then maybe it isn’t an emerging country anymore.
‘It has become a very important player, both economically and geopolitically, and it is a very important player in the investment landscape. We have moved to have China as a standalone segment in our frameworks, so separate from both emerging and developed countries.
‘Our strong belief is that the weight of China in indices, both in equities and fixed income, will be much higher in five years’ time and, for that reason, we have a strong, long-term conviction on China both in the equity and fixed income markets.’