Demand grows for Asian investment products that exclude China

Global fund managers say they are rushing to meet client demand for new Asian investment products that exclude China, as investor appetite for the region’s largest economy is hit by slowing growth and mounting geopolitical risk.

Fund managers said requests for “ex-China” products included the possibility of “Asian allies” funds that would invest in US-friendly markets and provide clear insulation from Beijing-related geopolitical risk in the region.

The widespread adoption of such investing would mark one of the biggest structural shifts for Asia-Pacific markets since the advent of “Asia ex-Japan” portfolios roughly three decades ago, according to asset managers. They said demand had been stoked by worsening US-China tensions and a rally for the rest of the region that had left its biggest market behind.

“Investors are concerned about geopolitics,” said Minyue Liu, investment specialist at BNP Paribas Asset Management. Liu said international clients had begun sending out RFPs — requests for proposals — to provide investment funds that would cover the Asia-Pacific region but exclude both China and Japan.

“That means there’s a real opportunity, it’s not just investors asking about this hypothetically,” said Liu, who added that BNP Paribas AM was already in talks with clients about providing Asia ex-China investment products. “It clearly shows there’s interest in this kind of product.”

Investor concerns over China exposure came to the fore after Russia’s full-scale invasion of Ukraine, which drove many to reassess the risk of a Chinese assault on Taiwan. But fund managers said demand for ex-China investment products had grown more concrete in recent months thanks to worsening relations between Washington and Beijing and China’s lacklustre economic recovery.

The divergence is clear from the performance of the MSCI Emerging Markets Asia index, which has delivered net returns of just 1.3 per cent this year, compared to returns of 8.6 per cent for the MSCI EM Asia ex-China index. Among the top performers in the region are markets in South Korea and Taiwan, up about 20 and 30 per cent, respectively.

Christopher Lees, senior fund manager at J O Hambro Capital Management, said he had heard about potential client demand for “emerging markets ex-China and Asian allies products” as a way to tap into the region’s growth while concentrating exposure in countries with strong ties to the US.

“On geopolitics, there are a lot of different opinions among clients, but I think that anyone who thought the US-China tension was going to go away is now very aware that it will not,” Lees said. “At the same time, clients are seeing that they can get a lot of exposure to China through other markets like Australia, Japan and South Korea.”

However the main driver of the trend towards ex-China investment was “economic, not geopolitical”, he added, because many emerging markets investors viewed China’s weighting in investment benchmarks from the likes of MSCI and FTSE as too large, tilting the balance away from markets such as Vietnam, Thailand and Indonesia.

“This would be a clear echo of what we had with Japan 30 years ago,” said Lees. Back then, when both the size and volatility of the post-bubble Japanese market skewed Asian portfolios too much, demand rose for Asia ex-Japan products that have remained the fundamental approach to investing in the region.

“The ex-Japan approach has been well ensconced for at least three decades, and clients with whom we have direct mandates aren’t asking us: ‘Can you sell all of our China exposure?’” said Hugh Young, Asia-Pacific chair of UK asset manager Abrdn. “But there are certainly some large institutional investors out there who have gone ex-China.”

Foreign institutional investors are already taking steps to reduce exposure to China while boosting holdings elsewhere in the region. Goldman Sachs data based on customers’ trading flows show hedge funds’ allocation to Chinese equities has dropped from 13 per cent in January to 9 per cent at the end of May.

Total net inflows to China stocks this year have plateaued at about $26bn, following an initial jump in January as the country reopened. And the latest data show investors trading Chinese debt through Hong Kong’s Bond Connect scheme had dumped about $31bn worth of government bonds in the first four months of 2023.

In contrast, figures from ANZ bank show foreign investors have snapped up nearly $38bn worth of emerging Asia ex-China stocks and bonds this year, with net purchases of $22.4bn in May alone marking the largest monthly inflows since 2011.