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Emerging markets roundtable: An uneven recovery

Funds Europe – Given its size, does China really fit into an emerging markets portfolio, or should it be an asset class of its own? Also, what are the key risks involved when investing in the superpower?

Varsani – China’s current weight in the MSCI Emerging Market Index is around 40%, and that’s with the current 20% A-share inclusion. If that 20% rises to a hypothetical 100% inclusion scenario, then the weight of China in MSCI Emerging Markets goes to about 50%. So, as with the impact of the US in developed markets, which also has a very high weight, the risk/return characteristics of EM in that full scenario could be largely dominated by China. And if you exclude China, then the dynamics of EM would look very different given how country risk is very elevated in EM compared to DM [developed markets].

In the ACWI context, the weight of China is around 5% globally, but that 5% is quite low compared to what emerging market contributes to global GDP, so even though it has a 5% market cap weight, the contribution to global GDP is about 16%, which is actually on a par with – or not that far off from – where the US is, and so investors recognise that dedicated allocations to China could make sense, given its strong prospects going forward.

Slabber – How do we feel about Big Brother nowadays? Coming from an emerging market myself, China is Big Brother. On a light-hearted note, my subjective view is that China over the last decade is slowly but surely starting to accept that it has a role to play in the world. It’s too big to operate on its own, and big enough to operate on its own. If it wants to, it can operate solo, but it accepts its responsibility so doesn’t do so anymore. It’s increasingly opening up, giving more opportunity for the capitalist global economy to contribute and extract from China’s growth. We can’t live without them. Sometimes we battle to live with them, but the fact of the matter is it’s our Big Brother and we are all one family and we have to accept that. We don’t kick our family members out – we have to work with each other.

China is changing a lot. China accepts that there is no more a purpose for them to actually mislead anybody by doing things that are not going to work, because they are now participating in this global marketplace.

Bao – China is important to emerging markets, and it clearly understands that, but it’s too early to treat it as a separate asset class. Accessibility is improving but still remains an issue for some institutional investors.

The Chinese market is also really profound. The 400 million-strong middle class has already reached developed country wealth status and purchasing power, but the rest of the population – around one billion – is still at an emerging market status of income. That uneven development is creating a huge opportunity both domestically and internationally.

Spano – In ten years’ time, that middle class in China will probably increase to 700 million people, so we are going to have a Chinese middle class that is the same size as Europe and the US put together.

China is surrounded by US allies like Korea and Japan – do you think China is going to be allowed to grow smoothly without any type of intervention from the US? This is not only about finance. In ten years’ time the world is going to be completely different. Covid has spurred a strong acceleration of change in this world. China is going to become the number-one economy in GDP absolute terms. It is already the main leader amongst emerging countries: just look at the Silk Road, for example, or its influence in Africa now: it’s massive. How will this situation evolve? Is the US going to make it easy? I don’t think so.

Cardinale – We are in the middle of a regime change; the old globalisation model is gone and in the future it’s going to either be a bipolar or multipolar world. The US and China will likely be rivals. China has developed technology to rival the US, even compared to Europe, China is way more advanced. However, it still has bottlenecks in some areas, so if the US really wanted to prevent China from developing further, there are avenues. If you think about semiconductors, there are some specific sectors where China is not completely self-sufficient. It will be an interesting tension – are we really moving toward a completely bipolar two-bloc system, or will it be a hybrid between the old globalisation model and a bipolar world? This is going to be one of the biggest questions.

Bao – The confrontation between the China and US is here to stay, it’s the new normal. We are seeing increased regionalisation, which means Asia-Pacific countries tend to play closer roles to take advantage of China’s driving power, while other emerging countries that are closer to the US are potentially seeking more solicitation, more regional support.

There is no reason for either China or the US to quickly resolve their issues. Let’s be frank, there is no right or wrong on the affairs between different countries, there are only the interests between different countries, so for the time being, China can still rely on its financial interests to attract more support from other emerging countries, but the US still has a strong hold of the legacy interests with its historic allies.