China trade tensions worry EM investors

Increasing their allocations to emerging markets (EMs) has left investors now fearful over the trade tensions countries are having with China.

There had been ongoing trade tensions between the US and China, which were expected to escalate in the run-up to the US presidential election, and there was also tension between China and Australia in recent months after Australia questioned China’s role in spreading the COVID-19 pandemic.

While many companies had increased allocations to emerging markets in recent years as the region grew in importance, this trade tension was making them nervous about having exposure to the market.

Ten years ago, there were less than 20 emerging markets funds, according to FE Analytics, but this had increased to almost 50 in September 2020. The largest of these were the Mercer Emerging Markets Share and the Vanguard Emerging Markets Share Index funds which were both had over $1 billion in assets under management.

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Over five years to 31 August, 2020, these two funds had returned 27% and 17.6% respectively versus returns of 18% by the emerging market sector.

Meanwhile, in the Asia Pacific sector, this had grown from 16 funds a decade ago to 28 and the largest was the Platinum Asia fund at over $4 billion.

Seema Shah, chief strategist at Principal Global Investors, said: “Investors have meaningfully increased their strategic exposure to emerging Asia in recent years, driven by the region’s favourable demographics, stable political systems and pro-growth policymaking. At the same time, much of EM Asia’s gains were contingent on China’s success.

“Understandably, therefore, investors may be worried about China’s evolving diplomatic implications and the deliberate global shift from China,” Shah said.

She said, while China’s stockmarket performance had remained largely resilient, investors would be wise to keep an eye on the geopolitical situation in Asia, particularly regarding China’s relationship with the US. The Shanghai Composite Index had returned 11.7% over the past year.

“There are still numerous reasons to maintain strategic exposure to Asia ex China economies,” Shah said.

“The geopolitical environment, however, carries some material risks. The shifting US political climate may increase the likelihood of governmental interference in capital markets. If it does, investors will need to factor that into their assessment of Chinese stocks and, by inference, the EM Asian assets.”

Eric Stein, co-director of global income at Eaton Vance Management, said the trade tensions between the US and China were unlikely to cease even if there was victory for Joe Biden.

“Clearly, the Trump administration has shifted the narrative on China- essentially the only bipartisan issue in Washington where everyone has been trying to out hawk each other,” Stein said.

“If Biden gets elected, I don’t expect him to go soft on China as Trump has claimed but rather be far more hawkish than he was as vice president in the Obama administration.”