The Appeal of Ex-China Emerging Market Strategies

Institutional investors are significantly reallocating from China-centric emerging market exposures to "ex-China" strategies, driven by escalating geopolitical tensions, regulatory uncertainties, and China's economic slowdown. This shift is evidenced by substantial inflows into ex-China EM equity ETFs, notably €8.1 billion into European-listed funds in the first seven months of 2025. This strategic pivot enables access to diversified growth opportunities in markets like India, Brazil, and Mexico, while mitigating China-specific risks, though it introduces considerations such as lower liquidity in smaller markets and increased concentration in other major EM economies.

Analysis

A significant structural shift is underway in emerging market (EM) allocations, characterized by a deliberate investor rotation out of China-centric strategies. This trend is driven by mounting geopolitical risks, unpredictable domestic regulatory actions in key sectors like technology, and a decelerating Chinese economy, with IMF growth projections moderating to 4-5%. Strong evidence for this reallocation is seen in fund flow data; European-listed EM equity ETFs attracted €8.1 billion in net inflows in the first seven months of 2025, surpassing the 2024 full-year total, while dedicated ex-China funds saw inflows exceeding $2 billion year-to-date as of Q2 2025. This pivot redirects capital towards a diverse set of markets including India, highlighted by Morgan Stanley as the fastest-growing major EM economy, Brazil, a key commodity exporter, and Mexico, a prime beneficiary of nearshoring trends. Investors are utilizing instruments like the iShares MSCI Emerging Markets ex China ETF (EMXC), which has grown to $12.85 billion in assets. While this strategy mitigates China-specific concentration risk, it introduces new considerations, including lower liquidity in smaller markets, currency volatility, and the potential for new concentration risks in countries like India and Brazil.

Key Decisions for Investors

• Investors should review their emerging market exposure to assess and potentially mitigate concentration risk in China, considering the structural headwinds and clear shift in fund flows.
• For implementation, consider established passive vehicles like EMXC for broad exposure or actively managed funds like EMM, as active selection can be critical in navigating the disparate risk and liquidity profiles of non-China EMs.
• While diversifying away from China, it is imperative to actively monitor the distinct risks of the remaining EM constituents, including currency volatility and the macroeconomic stability of new heavyweights like India and Brazil.
• The move to ex-China strategies should be viewed as both a tactical hedge against near-term volatility and a long-term structural allocation to a more diversified set of global growth engines.