Global investors are increasingly choosing to avoid China’s markets in favour of those of other rising nations that are either benefiting from or far removed from the geopolitical and growth uncertainties that loom over the world’s second-largest economy.

According to Reuters data, as American and European investors become more hesitant to have exposure to the Asian superpower, the assets of emerging market (EM) mutual funds and exchange traded funds (ETFs) that omit China have experienced a significant increase.

Following a shaky post-COVID economic recovery, unhappiness over the lack of a substantial policy response, and resurgent Sino-U.S. tensions over trade, technology, and geopolitics, investor hostility to China has increased this year.

Some of the money has been channelled to markets that are directly benefited by China’s economic woes, such as Mexico, India, Vietnam, and other places that are taking its place in international supply chains for manufactured goods. Simply put, other investors are relocating to areas like Brazil that have stronger growth potential.

“China’s export dominance is ebbing, creating opportunities for other emerging market countries to fill the gap, including Mexico, India, and Southeast Asian nations,” said Malcolm Dorson, a New York-based senior portfolio manager at ETF manager Global X.

According to him, such capital flows could continue for the ensuing ten years depending on how much transformation the world’s supply chains require.

According to Refinitiv statistics, mutual funds with a concentration on China saw a net outflow of $674 million during the second quarter of this year, while EM ex-China mutual funds saw a net inflow of about $1 billion.

The largest emerging market ex-China ETF in the world, the iShares MSCI Emerging Markets ex-China ETF, which mostly invests in companies in Taiwan, South Korea, and India, saw a record net inflow of $1 billion in the first half of 2023, according to the statistics.

Such ETFs and funds also provide options to monitoring that index, which includes China in almost a third of the EM MSCI index.

“China is the one major country that investors are most concerned about in EM,” said John Lau, portfolio manager for Asia Pacific and emerging market equities at SEI.

According to him, investors had stronger prospects than in China due to the favourable growth and values in Latin American markets, tech-driven tailwinds for businesses in South Korea and Taiwan, and supply chain developments.

According to Goldman Sachs data, as of mid-July, foreign investment in developing market Asia ex-China equity markets totaled $39 billion over the previous 12 months, surpassing foreign investment in mainland Chinese equity markets for the first time since 2017.

Over 40% less money has been invested in the top 10 China-focused mutual funds since their peak in 2021, according to Morningstar.

By the end of June, the renowned UBS China Opportunity Equity Fund’s assets had decreased to $4.5 billion, or one-fourth of their value in January 2021.

GIC, a sovereign wealth fund based in Singapore, has “incrementally” shifted its capital, according to CIO Jeffrey Jaensubhakij, and the majority of it “has been basically out of China into countries such as Mexico, India, Indonesia, and Vietnam.”

Fund managers and advisors are finding it challenging to draw capital to China-focused products.

“In the last six to 12 months, there have been almost no queries for a China-focused mandate,” said Benjamin Low, a senior investment director at Boston-based advisory firm Cambridge Associates.

Instead, he said, some of his customers are considering ex-China exposures in other parts of Asia, such Japan.

While the Nikkei index in Japan is up 25% and the S&P 500 is up nearly 19%, China’s CSI 300 index has been flat for the year.

After President Joe Biden’s administration enlarged the forbidden list to include industries like chips and quantum computing, investors who had already grown wary because the Donald Trump administration forbade American investments in Chinese military enterprises have become even more wary.

While many of these restrictions are applicable to venture capital and exports, portfolio investors are leery about breaking investment prohibitions or falling victim to sanctions.

“The situation is even worse than last year when investors still had something (i.e. reopening) to look forward to,” said a business development manager at a Hong Kong-based hedge fund, who is not authorized to talk to media.

The fund was able to turn a profit in the first half of the year despite a difficult market, but in recent months, it has been difficult to find new funding from international investors, according to him.

Although it’s too soon to determine how China’s announcement this week to increase stimulus measures to support the economy would affect foreign money inflows, it gives investors some cause for optimism.

Western institutional investors are concerned about rising reputational concerns in addition to financial problems. According to portfolio managers, it is getting harder to defend China investments even to management and internal compliance departments.

For instance, Canada had a parliamentary hearing in May to inquire about the connections between various domestic pensions and China.

The Biden administration is reportedly drafting an executive order that would limit American investments made abroad in China.

“U.S., Canadian, and some European investors are exiting China due to political pressure. On the face of it, the U.S. seems to have started an investment war, following a trade war, and a tech war,” said Wong Kok Hoi, chief investment officer of APS Asset Management.

(Adapted from Reuters.com)

Categories: Economy & Finance, Geopolitics, Regulations & Legal, Strategy