How to invest in Asia without China

  • You can get exposure to Asian growth without investing in China and still tap into strong growth
  • Taking this strategy could mean that your portfolio is concentrated on volatile markets such as India and Vietnam
  • There are not many funds available which invest in Asia without China

If you invest in Asia, China equities are likely to account for a large part of your allocation, especially if you invest via passive funds which track regional indices. However, there are economic and ethical reasons why you might not be comfortable with exposure to China, and it is possible to tap into strong Asian growth potential without investing in this market.

China is no longer the fastest-growing economy in emerging Asia. Some Association of Southeast Asian Nations (Asean) countries – Indonesia, Philippines, Malaysia, Thailand and Vietnam – are collectively expected to grow faster than China this year and next year. “We can see evidence that manufacturers from both China and the west are looking to shift capacity into these markets to diversify and de-risk their exposures,” says Vivek Bhutoria, emerging markets portfolio manager at Federated Hermes.

Darius McDermott, managing director at Chelsea Financial Services, adds that “the Asean region is a fair bit smaller than the Chinese market, but still has some strong growth drivers, particularly in countries such as Vietnam which is looking to take market share off China as a new manufacturing powerhouse. Post-covid, many countries and companies are looking to diversify their supply chains away from China which could be a positive for many other countries in the region.”

And Ryan Lightfoot-Aminoff, senior research analyst at FundCalibre, points out that a number of growth drivers in the region do not involve China, such as the domestic Indian growth story which “has a multi-decade runway and offers excellent demographics, huge potential and aligned politics”.

Bhutori expects India to grow faster than Asean and thinks that it offers “the most exciting set of opportunities in emerging markets. [It is] a young, fast-growing working age population, has a government undertaking economic reforms, and a domestic economy in which most goods and services are highly underpenetrated, providing very long runways for many companies to grow.”

Taiwan and South Korea, meanwhile, offer exposure to the advanced semiconductor and hardware industries which dominate their respective stock markets and underlie many emerging technologies such as artificial intelligence software and driverless cars.

It is also possible to benefit from Chinese economic growth and its burgeoning middle class spending without buying Chinese equities, which come with the risk of political interference and greater uncertainty on shareholder rights. You can do this by “investing in the wider region, which benefits from these trends, or even western companies exposed to China”, says Rob Morgan, chief analyst at Charles Stanley.

There are economic concerns on China including about its housing and banking sector. More than 100 real estate projects in 19 provinces and municipalities in China are reported to be exposed to mortgage defaults.

The Chinese government is clamping down on companies which it thinks offer excessive pay and shareholder rewards. “It is taking stakes in successful companies to gain greater visibility of their actions at the same time as strengthening regulatory powers and probes,” says Morgan. “Attacking the entrepreneurs who can innovate and create more jobs is not a wise move and the potentially heavy hand of central government is ever present. Investors have to weigh up whether the enticing valuations [of Chinese equities] are worth it, in terms of sufficient return accruing to shareholders.”

If you include ethical considerations when choosing where to invest, there are many human rights concerns over China’s conduct such as its treatment of the Uyghur population in the Xinjiang region, and lack of freedom of speech and democracy. Also, if China invades Taiwan – as some fear – its equity markets could fall sharply.

Risks of excluding China

If you exclude China-listed equities from your portfolio you are likely to miss out on potential growth. “While it is a volatile market, as we have seen in recent years, it can make a lot of money in a short time,” says McDermott.

There is tremendous growth and innovation among mainland Chinese companies and, as Morgan points out, “unlike the US tech sector valuations are very appealing”.

China is a dominant player in industries which will continue to grow rapidly over the next few decades such as solar power, and batteries for electric vehicles and energy storage.

“In the near term, China’s domestic economy and stock market also are due a rebound after having spent over a year suffering the effects of zero covid policies, new regulations on the tech industry, property regulations and energy supply issues,”  says Bhutoria. “Over the medium term, China has many advantages: a huge domestic economy, an increasingly well educated and incredibly hard working labour force, and many world leading industrial businesses.”

Not having China as part of your Asian equity exposure could make your portfolio highly reliant on other areas in the region such as India “which carries its own risks [and] is quite an expensive market,” says Morgan. “And sentiment can be fickle here too.”

Asean economies and stock markets, meanwhile, are much smaller, meaning that there can be liquidity issues and less mature companies.

And not holding China equities would not reduce geopolitical risk argues Morgan. If China invades Taiwan, “Chinese equities would be most affected, but so would Taiwanese and Hong Kong stocks. And [the effects] would ripple through all markets.”

The managers of TB Guinness Asian Equity Income Fund (GB00BMFKG667) recently commented that “the big story in Asia is the easing of conditions in China as the zero-Covid policy lockdowns imposed during the first half are lifted. Inflation in China is more moderate than in the rest of the world, and China’s monetary and cyclical position gives room to the government and central bank to direct policy towards acceleration of growth. There is the probability that Chinese inflation pressures may emerge as demand recovers, but we think this will take time.”

Energy inflation is more benign in major emerging markets such as China and India which are among the world’s largest coal producers, and consumers are benefiting from domestic coal prices that are lower than seaborne prices. Retail energy prices are also regulated in a number of major Asian economies including China and India.

“Likewise, selected food prices are regulated and markets like China, India and Brazil, which have a high level of self-sufficiency, are less dependent on food imports,” adds Chetan Sehgal, manager of Templeton Emerging Markets Investment Trust (TEM).

Funds for less China exposure

Chinese equities are the dominant allocation across the majority of emerging markets and Asian equity exchange traded funds (ETFs) and active funds, limiting the options available for investing in Asia without China.

You could buy single country funds and or ETFs focused on other countries in the region such as India. However, single country emerging markets funds are very high risk. In particular, passive funds which replicate the markets of these countries can be volatile and heavily focused on certain companies or sectors.

For example, iShares MSCI Taiwan UCITS ETF (ITWN) had nearly a third of its assets in one holding – Taiwan Semiconductor Manufacturing (TAI:2330) – at the end of July and, in terms of its sector allocation, 62 per cent in information technology stocks.

Also see Taiwan Semiconductor and the EM fund dilemma (IC,19.08.22)

HSBC MSCI Indonesia UCITS ETF (HIDD) had 53 per cent of its assets in financials at the end of July, with its two largest holdings, Bank Central Asia (INDO:BCCA) and Bank Rakyat Indonesia (INDO:BBRI), accounting for 22.3 per cent and 16.27 per cent of its assets, respectively.

The Vietnam market, which is tracked by funds including Xtrackers FTSE Vietnam Swap UCITS ETF (XFVT), is better diversified but can be volatile.

Single country ETF annual total returns (%)
Fund 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 2012
HSBC MSCI Indonesia UCITS ETF 18.67 1.99 -10.53 3.39 -3.81 12.99 40.12 -15.73 32.90 -24.32 -0.96
iShares MSCI Taiwan UCITS ETF -11.56 29.85 30.42 29.84 -3.88 16.59 41.93 -7.84 14.02 6.31 10.82
Xtrackers FTSE Vietnam Swap UCITS ETF -14.99 33.66 13.67 0.55 -6.19 36.66 16.89 -11.46 16.05 9.12 14.98
Source: FE Analytics, 23 August 2022

Active funds can avoid or have lower weights to certain companies and sectors than the indices which cover the countries they invest in, which can help to reduce volatility. There are a number of single country active funds focused on India such as Goldman Sachs India Equity Portfolio (LU0858290173) whose manager, Hiren Dasani, aims to invest in businesses of various sizes. He and his team also evaluate the attractiveness of a company’s industry and the valuation of a business, preferring real cash flows to paper profits.

At the end of July its largest sector allocations were financials and technology which accounted for 25 per cent and 16 per cent of its assets, respectively. Its largest holdings, ICICI Bank (IND:ICICIBANK) and Infosys (IND:INFY), accounted for 8.4 and 7.6 per cent of its assets, respectively.

Another option is to hold a broader Asia fund which is flexible enough to be underweight China. McDermott highlights Jupiter Asian Income (GB00BZ2YND85) whose manager, Jason Pidcock, has recently reduced the China allocation because he has become increasingly uncomfortable with domestic Chinese politics and the souring of relations with other countries.

“The fund still has indirect exposure to the Chinese economy through businesses in neighbouring countries that sell goods or services to China,” explains McDermott.

The fund’s largest country allocation at the end of July was Australia, which accounted for 38.1 per cent of its assets, followed by Taiwan and Singapore which accounted for 16.6 and 15.1 per cent, respectively. It is well diversified across sectors and its largest exposures were technology and financials which each accounted for around a fifth of its assets. Pidcock aims to invest in companies which he believes are well managed and positioned within their industries, with scalable business models and managements committed to sharing profits with shareholders.

Pacific Assets Trust (PAC) includes China in its potential investment universe but only had 9.2 per cent of its assets in Chinese equities at the end of July.

“It has a very clear focus on high-quality companies with strong balance sheets and good governance,” says Morgan. “It is invested heavily in India, which can be a volatile market. Pacific Assets Trust’s share price [returns] can be volatile as the discount or premium to net asset value (NAV) it trades on shifts according to sentiment. It doesn’t have gearing [debt] like some trusts, though. It hasn’t been particularly volatile in the context of the region owing to [its managers’ focus] on good quality, resilient companies with strong managements.”

Stewart Investors Asia Pacific Sustainability (GB00B0TY6V50) is run by the same manager, David Gait, via the same approach. It is potentially less volatile than Pacific Assets Trust as it is an open-ended fund and continually priced at NAV.

Legal & General Pacific Index Trust (GB00BG0QPB53) tracks FTSE World Asia Pacific ex Japan Index so invests in countries including Taiwan, which accounted for nearly a quarter of its assets at the end of July, and South Korea, Hong Kong, Singapore, Thailand and Malaysia. It has a significant focus on developed markets with Australia and New Zealand accounting for about a third of its assets, so does not have the growth potential that a fund with a decent allocation to China and or emerging Asian markets might have.

Specific Asean funds include Barings ASEAN Frontiers (IE00B3BC5W20) which has a good long-term record of outperforming its benchmark, MSCI AC ASEAN index. Its managers, SooHai Lim and Tiebin Liu, aim for growth over the long term via exposure to emerging Asia’s favourable demographics, opportunities arising from underpenetration of goods and services, infrastructure build-out and accelerating consumption. They select companies on the basis of their individual merits.

Performance
Fund/benchmark 1-yr total return (%) 3-yr cumulative total return (%) 5-yr cumulative total return (%) 10-yr cumulative total return (%)
Barings ASEAN Frontiers 0.01 16.26 36.84 99.84
MSCI AC ASEAN index 12.36 -4.83 4.37 40.90
Pacific Assets Trust share price -0.28 17.79 37.73 196.61
MSCI AC Asia ex Japan index -3.01 17.39 19.24 118.00
Stewart Investors Asia Pacific Sustainability  2.66 34.25 61.34 222.29
MSCI AC Asia Pacific ex Japan index -0.84 18.57 22.17 114.60
Jupiter Asian Income 15.29 30.28 44.69  
Legal & General Pacific Index Trust** 1.78 27.61 34.70 124.63
FTSE Asia Pacific ex Japan index 0.50 21.95 25.55 119.45
IA Asia Pacific Excluding Japan sector average -1.90 20.67 27.03 122.24
Goldman Sachs India Equity Portfolio 7.14 66.56 56.70 327.34
MSCI India index 18.57 63.66 67.55 219.10
MSCI China index -12.32 -4.85 -3.97 100.51
Source: FE Analytics, 22 August 2022
**The history of this unit/share class has been extended, at FE fundinfo’s discretion, to give a sense of a longer track record of the fund as a whole.

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