Emerging markets (EM) have dramatically transformed over the last three decades.

EMs have become a powerhouse of the global economy, contributing around 59% of the total world GDP (based on PPP terms) (Chart 1).1

Chart 1. EMs contribute to nearly 60% of global growth

This growth is underpinned by a young, expanding, and increasingly wealthy middle class. Over the last decade, China was primarily responsible for EM’s growing influence. However, we believe this is about to change as EMs outside China rapidly catch up and exert their economic and political influence on the international stage.

Investors are strategically considering the option of diversifying their EM allocations into China and ex-China strategies.

Investors are strategically considering diversifying their EM allocations into China and ex-China strategies. This approach aims to enhance their ability to manage China risk effectively while exploring attractive EM investments beyond the world’s second-largest economy. This strategic move empowers investors to navigate the evolving global market dynamics with confidence.

Beyond the dragon’s reach

Despite their classification, EM are less homogenous than their developed market counterparts. Emerging economies are at different stages of growth, with diverse demographics, structural tailwinds, and policy priorities. EM manufactures most of the world’s goods – from high-end semiconductors to food staples like coffee, tea, and cereals. They’re also resource-rich, supplying the world with much of its oil and raw materials.

Meanwhile, EM companies are expanding their global presence through innovation and often turn to public markets to raise funds for capital expenditures.

The integration of EM into global capital markets is not uniform. However, it’s evolving as individual capital markets open to international investors and become more sophisticated.

As an asset class, EM remains underrepresented in global markets. EM equities account for around 11% of the free-float weighted equity market (MSCI All Country World Index).2 At the same time, Chinese equities remain underrepresented in global indices relative to the country’s global economic influence.

EM ex-China has a large market capitalization, offering depth and liquidity.

EM ex-China has a large market capitalization, offering depth and liquidity. As of the end of July 2023, EM ex-China accounted for almost half of the constituents on the MSCI EM Index (674 out of 1,374 stocks), but the total investable universe is much bigger.3 We believe structural opportunities in EM ex-China offer significant alpha generation potential.

China’s Influence on EMs

China is the largest country driving EM performance and can become more dominant over the coming decades. In 2018, MSCI started to include China A-shares – stocks that trade on domestic exchanges on the mainland – in the EM Index. Today, China’s weight on the index is around 26.69% – while it has come down from around 30% last year due to the sharp sell-off in the market, it is still significantly ahead of the likes of India (18%) and Taiwan (17%) (Chart 2).4

Chart 2. China’s growing dominance of the MSCI EM Index

China remains a fertile hunting ground for long-term, fundamentally driven investors. However, geopolitics remains a concern, while domestic policy can create heightened volatility. As a result, investors want more control over their China exposures.

Investors want more control over their exposure to China.

By contrast, EM ex-China investments are subject to less top-down scrutiny. Over the past decade, domestic economic policies have become more orthodox. The influence of these policies is evident in the correlation in performance between the MSCI EM Index and the MSCI EM ex-China Index in recent years. Returns have diverged (Chart 3), particularly since the pandemic when Beijing’s policies frequently dictated market sentiment.

Chart 3. The post-pandemic uncoupling between EM and EM ex-China

We believe there’s merit in a separate, active EM ex-China strategy. Many global investors already have a direct allocation to China. Therefore, EM strategies that include China would double their exposure to the market. An EM ex-China strategy could offer portfolio diversification through attractive opportunities elsewhere within the asset class. It also means investors can separately manage their China exposures and risk.

Why EM ex-China?

The opportunity set outside of China is blossoming (Chart 4).

Chart 4. EM ex-China has plenty to choose from and is overlooked

Demographic and structural tailwinds are underpinning alpha-generation prospects in high-growth markets. There is a wide range of high-quality listed companies across EM ex-China, with solid fundamentals and attractive valuations (Chart 5).

Chart 5. EM ex-China c. 1200 listed larger cap stocks >US$2 billion market cap

The list is endless, from Taiwanese chipmakers and South American copper producers to Middle Eastern oil companies and Indian lenders and insurers. Many companies are also becoming global technology leaders (Chart 6).

Chart 6. EM ex-China companies are becoming global leaders in technology

Structural tailwinds

Several long-term structural drivers provide a tailwind for EM ex-China. This growth story frequently gets lost in the noise of quarter-and-quarter or year-on-year relative returns.

Consumption growth

Emerging and developing economies (ex-China) are home to some 5.4 billion people, most of them young. India has recently become the world’s most populous country, with a median age of 28. This compares to China (39) and the US (38). India is also the world’s third-largest consumer market behind the US and China. At the same time, the populations of large countries like Indonesia and Brazil are growing.5

Better macro management in EM ex-China is further supporting consumption growth. While the potential of EM is well known, domestic economies have struggled as external pressures buffeted consumers via currency fluctuations, inflation, and debt. Today, the currency dynamics for EM look favorable. External balances and government debt are in better shape. Meanwhile, domestic reforms, innovation, and urbanization push consumers into higher-income employment. Digitalization is creating new opportunities and driving faster economic growth. Combined, these set the stage for domestic consumption to flourish.

The rapid proliferation of digital technologies, underpinned by an abundance of smartphones and affordable internet, has caused a seismic shift in consumer behavior patterns – creating new economic sectors such as e-commerce. We’ve seen some of the biggest shifts in offline-to-online retail in India, Southeast Asia, Taiwan, and Latin America (Chart 7).

Chart 7. EM consumers are going online

Global technology drivers

Digitalization has become an important growth driver for emerging economies in the last decade. Technology is allowing EM to catch up with developed markets. Competitiveness and innovation across industries have grown – from automation to electric vehicles to renewables. Much of this can be attributed to the dramatic rise in the prominence of many Chinese internet and fintech businesses.

However, numerous EM ex-China companies are shaping the next phase of the digital revolution. This includes many of the world’s leading manufacturers of semiconductors – those vital chips used in laptops, smartphones, cars, industrial equipment, high-performance computing, and more. Semiconductors are also driving the megatrends of the future, notably 5G and AI (artificial intelligence). This is a burgeoning industry. By 2030, it’s expected to grow to US$1 trillion – averaging 6% to 8% growth annually.6

Digital transformation initiatives in the wake of the pandemic also stimulate demand for IT outsourcing services. Companies worldwide are competing for tech talent while trying to keep a lid on operating costs. This is creating opportunities for EM ex-China firms, particularly in India. The country remains the go-to destination for IT outsourcing thanks to exceptional cost advantages, a large English-speaking talent base, and skilled competencies that have been developed and fine-tuned over the last three decades. Latin America, Eastern Europe, and the rest of Emerging Asia also compete in this space.

Supply chain diversification and nearshoring

US-China trade tensions, COVID-related disruptions, and a substantial rise in Chinese wages have caused corporations to diversify their supply chains. Adopting a China plus-one strategy, many are moving parts of their operations out of China and into EM countries with similar demographics, low production costs, and relative political stability.

Numerous countries in the EM ex-China universe [are benefiting from corporations diversifying their supply chains], including India, Vietnam, Thailand, Indonesia, Mexico, and Malaysia.

Numerous countries in the EM ex-China universe fit the bill, including India, Vietnam, Thailand, Indonesia, Mexico, and Malaysia. They’ve put forth plans to attract foreign direct investments from multinational companies. Initiatives include improving the ease of doing business, production-linked incentive schemes (as seen in India), favorable corporate tax structures, and better domestic infrastructure. For example, a Taiwanese multinational electronics manufacturer – Apple’s main supplier – reportedly plans to invest nearly US$500 million to build two component factories in India as part of its diversification efforts away from China.7

Furthermore, several US companies are setting up production closer to home. Mexico is a notable beneficiary of this nearshoring thanks to its proximity to the US, competitive labor costs, and favorable tax conditions (Chart 8).

Chart 8. Leading indicators in Mexico suggest a long runway of benefits from nearshoring …

Indeed, many car manufacturers that sell in the US have factories in Mexico. In March, for example, a Texas electric vehicle company announced it would build its next factory in Mexico (Chart 9).8

Chart 9. … With commercial vacancy rates falling, especially in northern Mexico

Additionally, manufacturing wages in Mexico have remained steady over the last decades, at a little over US$2 an hour. This compares favorably to China, where wages have increased threefold to around US$6 an hour over the same period.9

Abundance of commodities

Many EM countries are endowed with natural resources, which makes their economies closely linked to commodity prices. Exporters in Latin America and South Africa should benefit from long-term global decarbonization efforts. Over the short-to-medium term, Middle Eastern oil will still be needed while nations and companies build the green infrastructure of tomorrow.

In its early stages, the energy transition is leading to an increased demand for raw materials such as lithium and copper – both essential for electric vehicles, among other things. Latin America is the largest producer of these materials by region (Chart 10).

Chart 10. Copper supply constraints are meaningful and long term

At the same time, capital flows into the Middle East are creating new opportunities outside energy. Many countries have enacted comprehensive reforms to transform their economies and diversify away from energy. Take Saudi Arabia and its Vision 2030. Here, there’s been a concerted effort to attract international investors, creating opportunities in areas like consumption and other structural compounders that were previously unavailable.

What does the universe look like?

The EM ex-China universe not only gives exposure to other high-growth markets but also access to companies driving economic growth across various sectors. Unlike the MSCI EM Index, no one country or sector dominates the benchmark.

At the country level (Chart 11), Taiwan, India, and South Korea each account for around or less than 20% of the MSCI EM ex-China Index. Brazil and Saudi Arabia also have significantly bigger weights in the index than compared with the MSCI EM Index.

Chart 11. MSCI EM ex-China vs. MSCI EM

At the sector level (Chart 12), Information Technology and Financials are the largest in both indices. However, consumer sectors are a bigger part of the MSCI EM Index, partly due to China, whereas the ex-China index has a larger weight towards Materials and Industrials.

Chart 12. Sector weights vs. MSCI EM Index

Final thoughts

EM ex-China is at an inflection point. EM have performed below their potential for over a decade, struggling against external pressures such as currency fluctuations and debt. Following robust reforms and better macro management, conditions have turned positive for the asset class.

Many previously unappealing EM regions are slowly becoming attractive investment opportunities.

The currency dynamics look better. External balances and government debt are improving. Meanwhile, capital markets have deepened and grown more sophisticated. Long-term digitalization and innovation create seismic shifts in consumption patterns and business models. Many previously unappealing EM regions like the Middle East are slowly becoming attractive investment opportunities. All of this is helping to transform emerging economies, and it’s also gradually reflected in the asset class’s performance.

What does this mean for China? The country’s meteoric rise has overshadowed EM for over two decades. Increasingly, however, clients want more control over their exposure to China and risk. We therefore believe there’s merit in having a separate, active China strategy – which remains a fertile hunting ground for long-term, fundamentally driven investors.


1 "GDP based on PPP, share of world." International Monetary Fund, April 2024. https://www.imf.org/external/datamapper/PPPSH@WEO/WEOWORLD/ADVEC/OEMDC.
2 Bloomberg, MSCI All Country World Index, May 2024.
3 Bloomberg, MSCI Emerging Market Index, May 2024.
4 "Index Factsheet." MSCI Emerging Markets Index (USD). MSCI, April 2024. https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111.
5 International Monetary Fund, July 2023.
6 “The semiconductor decade: A trillion-dollar industry.” McKinsey & Company, April 2022. https://www.mckinsey.com/industries/semiconductors/our-insights/the-semiconductor-decade-a-trillion-dollar-industry.
7 “Apple supplier Foxconn plans $500 million component plants in India.” Bloomberg, July 2023. https://www.bloomberg.com/news/articles/2023-07-31/apple-supplier-foxconn-plans-500-million-india-component-plants.
8 "Tesla confirms its next Gigafactory will be in Mexico.” The Verge, March 2023. https://www.theverge.com/2023/3/1/23571725/tesla-gigafactory-monterrey-mexico-announce-investor-day.
9 "As China’s wages rise, Mexico beckons manufacturers." Quartz, November 2022. https://finance.yahoo.com/news/chinas-wages-rise-mexico-beckons.html.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.