Seeking ex-China opportunities? Manage EM risk with ETFs

The case for emerging markets

There is a myriad of reasons to consider EMs from a long-term perspective, including numerous economic and demographic advantages – they are the chief drivers of overall global growth, accounting for 50.1% of global GDP in 2023, and 66.7% of global GDP growth in the prior decade.¹

They are also enjoying rapid industrialisation, house most of the world’s population, have a young workforce - more than 40% of India’s population is under the age of 25 - and enjoy a rapidly growing middle class.²  One analysis estimates that by 2030, most emerging market consumers, at 75%, will be between the ages of 15 and 34 – and will be more optimistic about the economy and willing to spend.³

From a wider perspective, there have been some positive developments which have bolstered EMs’ success during 2024.

For example, economic growth has been resilient despite the weakness of China. The International Monetary Fund (IMF) expects emerging market and developing economies to now grow by 4.3% in both 2024 and 2025, up from previous estimates of 4.2% - with the upward revision down to “stronger activity in Asia, particularly China and India”.⁴

Companies in countries like India, China, Indonesia, Mexico and Saudi Arabia tend to enjoy increased revenues when developed market growth is strong. This not only has positive effects on these countries’ domestic economies but also provides support for direct investment into their equity and corporate bond assets.

Navigating geopolitical influences

Investing in the world’s developing economies has always been synonymous with the high-risk, high-reward mantra.

The more typical problems associated with them include political – and often geopolitical instability, lax regulation, and a lack of transparency in company information, compared to developed markets.

EMs likely face a deteriorating external environment in 2025-2026, which will further test their resilience. EMs withstood a series of shocks over the past five years - the pandemic, an inflationary surge and 2022’s terms-of-trade shock (higher energy and food prices). The prospect of greater US trade protectionism during Donald Trump’s second term, as well as continued challenges facing China’s policymakers in reviving their sluggish economy, present downside risks to EM economic growth. We see risks on the downside for oil prices – reflecting increased supply, Trump’s deregulation agenda and global growth deceleration – but geopolitical tail risks in the Middle East could trigger a temporary spike in oil prices. Trump has pledged to end the Ukraine war but the terms of a resolution could have consequences for security arrangements for EM Europe, requiring an expansion in defence spending at a time when debt ratios and interest rate payments are elevated.

Trump has wasted little time re-invoking geographical trade tensions as his second stint at leading the country begins in earnest. Newly imposed tariffs against Mexico, Columbia, Canada and China will have come as little surprise to those familiar with his campaign pledge rhetoric to promote US business interests and facilitate US onshoring via domestic trade protectionism tactics.⁵  While the true impact of a renewed trade war on developed and emerging countries alike is yet to fully play out, global markets have initially reacted poorly to these measures, with some announcing retaliatory punitive US trade terms, and many anticipating a spread to EU countries and beyond.⁶

Against this backdrop, policymakers across EMs will continue to need to deliberate over decisions that prepare for, or react to, changes beyond their control, while adjusting monetary and fiscal policy to support domestic demand without risking a reacceleration in inflation or generating fiscal crises.

Numerous new governments have been formed over the past year across EMs and this provides the opportunity for meaningful reform agendas to be implemented. But success in driving up investment will be as much about avoiding policy mistakes as it will be about delivering structural reforms to improve competitiveness and productivity.

However, higher tariffs on China’s goods could potentially benefit its competitors, particularly manufacturers in EM Asia that have struggled to compete with China on price. Yet any benefit will depend on the extent of the likely yuan depreciation.

Although China’s significance as an export destination for EMs has been limited recently by weak domestic demand, China still accounts for a large share of many EM exports. Much of this comprises commodities and raw materials as well as intermediate goods that ultimately feed into Chinese industrial production and manufacturing exports. Thus, any constraints on China’s exports will negatively hit EM suppliers.

To compensate for any shrinkage in US demand following a potential hike in tariffs, Chinese exporters could redirect these goods to other markets. Fearing a surge in low-cost Chinese imports undermining the competitiveness of domestic suppliers, EMs could attempt to erect new, or raise existing, trade barriers to China. Indonesia has already taken such steps. But this risks retaliatory measures from China, which accounts for a relatively large share of EM imports and increasing foreign direct investment (FDI) flows into South-East Asia.

What tools are available to investors seeking to manage exposure to Chinese stocks?

Choosing an ETF which passively tracks the MSCI Emerging Markets® Index can offer investors instant exposure to a diverse range of opportunities across developing markets. While the growth potential of emerging markets equities is best regarded as a long-term opportunity, the increased liquidity profile of an ETF may also provide a suitable vehicle for those with specific risk management criteria, helping to provide greater flexibility during times of increased volatility. Furthermore, a climate-linked index (PAB) can further open access to these opportunities by improving overall sustainability credentials than the standard parent index and potentially help to address environmental, social and governance (ESG) disclosure barriers.

Investors who wish to obtain wider emerging market exposure, yet already have significant exposure to China may need to choose a different approach than the standard MSCI EM PAB index, in order to satisfy country or geographic sales revenue exposure limits within their own portfolios or mandates. In these scenarios, the MSCI EM ex-China PAB index could provide an ideal solution.

Conversely, a decision to invest in an ex-China index may be a positive one, rather than exclusionary. The MSCI Emerging Markets Climate Paris Aligned Index has a significant level of exposure to Chinese stocks (24% as of 31 December 2024).⁷  Choosing an ex-China index allows greater exposure to other emerging market opportunities. The IMF found that in 2023, net capital flows into emerging markets, excluding China, recovered from a post-pandemic low to US$110bn, or 0.6% of GDP in 2023 – the highest level since 2018.⁸  Metals like copper and nickel - key components in clean energy and EV infrastructure - are likely to be in higher demand as the world moves towards net zero. More than a third of global copper production comes from Chile and Peru while Indonesia, the Philippines and Russia account for two-thirds of nickel production.⁹

A one-size-fits-all approach to assessing the outlook for EMs risks over-simplification but while few EMs will avoid the negative consequences of the worsening external environment, domestic demand resilience has improved and overall growth will broadly stay the course (albeit at a below trend rate for most EMs). There is clear downside risk in the event of Trump going all-out on his trade protection threats, or a broader trade war, but there are also still upside risks for EMs if his campaign pledges turn out to be little more than initial bargaining chips or if China makes progress in reflating its economy.

Among the positive EM growth stories is India, with its economy becoming more resilient over the past decade, and with Narendra Modi securing another five years in office in the 2024 elections, current investment-promoting policies should continue.

In terms of its fiscal dynamics (low deficit and low debt), Indonesia’s new government under Prabowo Subianto is relatively well-placed to take steps to support the economy, and spending on infrastructure and industrial policies aimed at driving up domestic value-add will continue.

Elsewhere in Asia, Korea and Taiwan have benefited from the boom in AI investment, with sales from their advanced semiconductor manufacturers driving a strong recovery in technology exports. While non-technology exports appear to be losing momentum, investment in AI is set to persist over the medium-term horizon, and this will have positive spillovers to technology manufacturers across the region.

Investors with a higher level of conviction in the growth potential of companies based outside of China may therefore prefer the proportionate exposure of an index which contains a greater percentage of opportunities elsewhere in the EM universe.