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© Reuters. FILE PHOTO – Investors examine computer screens that display stock information in a Shanghai brokerage house, China on April 21st 2016. REUTERS/Aly Song//File Photo

By Mike Dolan

LONDON (Reuters) – If China becomes too difficult to price in wider investment indices due to Beijing’s unfolding regulatory crackdown on some of the country’s leading companies, the emerging markets universe may see some seismic shifts.

This is not to suggest that China has any plans to leave, but it does mean there may be a need to reevaluate the investment category China currently falls within in light of the rapidly changing risks.

Although there are uncertainties around China’s Big Tech firms and its common prosperity drive, many investors still believe in China. They also acknowledge that it’s getting more complicated to evaluate the risks in relation to other countries.

BlackRock, a giant asset manager, decided this summer that China should be treated as an independent investment. This raises the question about how ex-China investments will perform in an environment without China.

BlackRock has recommended that investors double their strategic weightings for Chinese equity, despite harsh criticisms from George Soros (an investor veteran) who called it a “tragic error” by pouring billions of dollars into China during a political sensitive period. This is in contrast to the small stock and bond weightings within global indices.

China has the third-largest weight in MSCI’s All-Country index. But, China’s 4.5% is less than Japan’s 6.6% or the almost 60% that U.S. companies have.

Although Blackrock (NYSE) believes China should have a greater than 10% weight, it admits that China’s market and corporate crackdowns in this year’s government – along with the larger political conflict between Beijing and Western capitals — will likely continue to cause uncertainty for some time.

The latest investment note by the largest money manager in the world warned that China could be a “distinctpole” for global growth, despite being less intense than recent years.

Tactically it stated it was breaking China free from the emerging markets orbit. It also suggested a neutral stance regarding China’s larger overall China weightings, as well as an overweight of its debt.

‘EXCHINA’

Given that China represents a whopping 34% weighting in MSCI’s emerging markets equity index, an “exChina” investment in EM would appear to be a very different proposition indeed.

The MSCI Emerging Markets ExChina Index has outperformed all other indices over the last three years. Despite the fact that the exChina index’s price/earnings values are more costly, this summer’s government activity changed all of that.

However, money flows show a very different picture. According to the Institute of International Finance, the majority of emerging market inflows were directed toward China last month. This is despite all of the concerns.

Furthermore, August saw net outflows of equity and loans from emerging markets that were not China. This is the first time since March 2020.

However, and perhaps ironically given the rising geopolitical tension, Taiwan is the second highest weighting in at almost 15% – with South Korea at 13%, India at 11% and Brazil at 5%.

It is a big question whether exChina indices should also be exTaiwan. It is possible that emerging investors looking to reduce China-related risk could consider re-allocating funds to less heavily populated countries.

As always, the diverse emerging world creates difficulties in aggregration. However, it is likely that every country will be affected economically and even politically by China’s developments.

It’s especially difficult when you consider Chinese equities. It is difficult to assess the regulatory impact and determine if it’s worthwhile. We are yet to buy the dip there,” said Morgan Stanley (NYSE:)’s cross-asset strategist Andrew Sheets.

Sheets said that “some of the smaller EMs might benefit.” Brazil has lower valuations than other markets and could provide an interesting example. Brazil only represents 4-5% MSCI EM, so there won’t be too many reallocations from China.

By Mike Dolan. Twitter: (NYSE:): @reutersMikeD. Sujata Ro’s additional reporting and charts were provided by Aaron Jude Saldanha. Emelia Sithole Matarise edited.



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