Emerging Markets--Beyond China
China has exhibited one of the most transformational evolutions ever seen in emerging markets (EMs), with its weight in the MSCI EM Index doubling over the past five years. But China’s own dynamic and mega-cap stocks have somehow skewed EM benchmarks’ performance. We believe that beyond China, EMs offer an attractive and differentiated opportunity set—one which drove our launch of our EM ex China Growth strategy. In this Q&A, Romina Graiver, partner, a portfolio specialist on our global equity team, discusses the opportunity set and process driving our strategy.
March 2023
Portfolio Specialist
Romina Graiver, Partner
China has exhibited one of the most transformational evolutions
ever seen in emerging markets (EMs), with its weight in the MSCI EM
Index doubling over the past five years. But China’s own dynamic
and mega-cap stocks have somehow skewed EM benchmarks’ performance.
We believe that beyond China, EMs offer an attractive and differentiated
opportunity set—one which drove our launch of our EM ex China Growth
strategy. In this Q&A, Romina Graiver, partner, a portfolio specialist on
our global equity team, discusses the opportunity set and process driving
our strategy.
Emerging Markets—
Beyond China
GLOBA L EQUITY
Investment Management
active.williamblair.com
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EMERGING MARKETS—BEYOND CHINA
Emerging Markets—Beyond China
Why did William Blair launch an EM ex China strategy?
Romina:
In brief, China has become the predominant
market within EM indices, and while there would
likely be some setbacks over shorter time periods, the
country’s weighting appears poised to continue increasing
over the long term amid the continued development
of the equity market, growth and innovation, and further
integration of China A-shares.
A natural consequence of the prominence of China’s
inclusion in main benchmarks, market depth, and
unique characteristics is that some investors may wish
to implement a dedicated strategic allocation to China,
seeking to benefit from the abundant alpha opportunities
China offers across sectors, market caps, and share
classes. Another consequence is that the focus on the
vast China opportunities may overshadow attractive
investments in smaller emerging markets.
By launching our EM ex China Growth strategy, we seek
to offer the potential for alpha generation across sectors,
regions, and market capitalizations in the broad EM
space—in Asia; Emerging Europe, Middle East and Africa
(EMEA); and Latin America. This allows investors to have
a deeper exposure to EM investment opportunities and
complement a China allocation, including a zero allocation.
Just how big a role in EM indices does China play, and
can you go into more detail about how that influenced
the decision to launch an EM ex China Growth strategy?
Romina:
Through its deep transformation and successful
economic growth over the past decades, China has become
the second-largest world economy, and Chinese companies
have capitalized on changes in consumer patterns and
scale and have become an engine of innovation and
sustainable value creation.
A natural consequence of this is that China’s weighting in
the MSCI EM Index has increased from almost nonexistent
in 2000 to 35% in 2022.
That said, China is still not even fully represented in
the MSCI EM Index because the index artificially caps
its domestic China A-share weighting, applying an
inclusion factor of 20% to China A-shares. If this inclusion
factor were 100%, China would represent closer to 45%
of the index.
As China’s share of world gross domestic product (GDP)
and listed market cap increases, so should its weight in
both the MSCI All Country World Index (ACWI) and MSCI
EM Index. Currently, China’s share of world GDP is 19%
and its share of listed market cap is 14%. These numbers
are expected to rise to 20% for both. As that happens,
China’s weight in the MSCI ACWI and MSCI EM Index
should continue to increase, as exhibit 1 illustrates.
Sources: Goldman Sachs and William Blair, as of December 31, 2022.
EXHIBIT 1
How China’s Index Weighting Could Increase
We believe China’s weightings in the MSCI ACWI and MSCI EM Index are likely to converge with its economic exposure over the next five years.
45%
40%
35%
30%
25%
20%
15%
10%
5%
0
GDP
Listed Market Cap
MSCI ACWI Weight
MSCI EM Index
MSCI EM Index (GDP-Weighted)
Chinaʼs Share of World
Share of EMs
19%
20%
14%
20%
4%
6%
34%
44%
42%
40%
2022 Estimated
2026 Estimated
WILLIAM BLAIR INVESTMENT MANAGEMENT
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3
Emerging Markets—Beyond China
(continued)
As a single country becomes such a prominent weight in
the benchmark, its performance has an overwhelming
impact on the entire asset class, blurring the contribution
from smaller countries. As a result, it makes sense to
differentiate that market from the rest of the space.
This is even more important in the case of China,
as its specific macroeconomic, political, and regulatory
developments have had a dominant impact on its equity
market performance, and was largely desynchronized
with the rest of emerging and developed markets. Exhibit 2
illustrates the decreased correlation between China and
other EMs and China and the developed world.
Source: Goldman Sachs and William Blair, as of February 2023.
Past performance is not indicative of future returns.
Indices are unmanaged and do not incur fees or
expenses. A direct investment in an unmanaged index is not possible.
EXHIBIT 2
Decreased Correlations Between China and Other Markets
Rolling 52-week correlations between various indices shows a decreased correlation between China and other EMs as well as China and the
developed world.
100%
80%
60%
40%
20%
0%
100%
90%
80%
70%
60%
50%
40%
30%
20%
Jan. ʼ11
Jan. ʼ13
Jan. ʼ15
Jan. ʼ17
Jan. ʼ19
Jan. ʼ21
Jan. ʼ23
Jan. ʼ11
Jan. ʼ13
Jan. ʼ15
Jan. ʼ17
Jan. ʼ19
Jan. ʼ21
Jan. ʼ23
MSCI EM Index vs. MSCI World Index
MSCI EM ex China Index vs. MSCI China Index
MSCI EM ex China vs. MSCI World Index
Linear (MSCI EM ex China Index vs. MSCI China Index)
MSCI China Index vs. MSCI World Index
4
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EMERGING MARKETS—BEYOND CHINA
Emerging Markets—Beyond China
(continued)
How is the EM ex China Growth opportunity set different
from the broad EM opportunity set?
Romina:
Ex China, EMs have much more technology
(particularly semiconductor and broad hardware),
materials, and financials and less consumer discretionary
and communications services than the MSCI EM
Investable Market Index (IMI), as exhibit 3 shows.
Heavyweights in these sectors such as Tencent, Alibaba,
Meituan, and JD.com are eliminated. The MSCI EM ex
China Index also has a higher weighting in commodities
than the MSCI China Index, as exhibit 4 shows.
Sources: Factset, Goldman Sachs, MSCI, and William Blair, as of January 31, 2023. EMs ex China are represented by the MSCI EM ex China Index. China is represented by the
MSCI China Index.
EXHIBIT 4
Commodity Sector Weights, China vs. Ex China Indices
Excluding China increases commodity weightings.
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Dec. ʼ00
Dec. ʼ02
Dec. ʼ04
Dec. ʼ06
Dec. ʼ08
Dec. ʼ10
Dec. ʼ12
Dec. ʼ14
Dec. ʼ16
Dec. ʼ18
Dec. ʼ20
Dec. ʼ22
Jan. ʼ23
China
EMs ex China
EXHIBIT 3
Sector Weights Differ When China Is Excluded
Ex China, EMs have more technology, materials, and financials stocks
and fewer consumer discretionary and communication services stocks.
Sources: MSCI and William Blair, as of January 2023. Shows sector weight
spreads.
8%
6%
4%
2%
0%
–2%
–4%
–6%
–8%
MSCI EM IMI ex China vs. MSCI EM IMI
Communication
Ser vices
Discretionary
Staples
Energy
Financials
Healthcare
Industrials
IT
Materials
Real Estate
Utilities
WILLIAM BLAIR INVESTMENT MANAGEMENT
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5
Emerging Markets—Beyond China
(continued)
From a regional perspective, as would be expected, when
China is excluded, there is less exposure to Asia: Asia
represents almost 80% of the MSCI EM Index and 70% in
the MSCI EM ex China IMI.
Eliminating China also boosts the weight of EMEA and
Latin America by 5.5% and 3.8%, respectively, vs. the MSCI
EM IMI.
Exhibit 5 shows the country weightings in the MSCI EM
IMI vs. the MSCI EM ex China IMI. Taiwan becomes
the largest market in the MSCI EM ex China IMI, alongside
India and Korea. But every other market, from Brazil
to Mexico, gets boosted as well. This certainly provides a
more balanced representation of EM countries within
Asia and regions other than Asia.
Sources: MSCI and William Blair, as of December 2022.
EXHIBIT 5
Country-Weighted Comparison of China vs. Ex China Indices
EMs other than China get a big weighting boost when China is eliminated
from the index, providing a more balanced country representation.
“EMs other than China get a
big weighting boost when China
is eliminated from the index.
”
Romina Graiver, Partner
MSCI EM ex China IMI
MSCI EM IMI
21.60%
20.28%
17. 4 6 %
7. 5 9 %
5.44%
3.54%
5.11%
7. 5 3 %
10.01%
1.35%
30.56%
Taiwan
China
India
Korea
Brazil
Saudi Arabia
Mexico
South Africa
Other EMEA
Other Latin America
Other EM Asia
15.10%
14.08%
12.13%
5.28%
3.78%
2.46%
3.55%
5.23%
6.80%
0.94%
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EMERGING MARKETS—BEYOND CHINA
Emerging Markets—Beyond China
(continued)
What does the investable opportunity look like when
you remove China?
Romina:
Even after removing China, EMs offer a deep
opportunity set with more than 1,000 listed larger-cap
stocks (those with at least $2 billion of market cap). More
than half of those trade at least $10 million per day. That
suggests that there are significant investable opportunities
in EMs ex China. For comparison purposes, exhibit 6
shows the number of listed stocks with greater than $2
billion in market cap for other indices.
EXHIBIT 6
Broad Opportunity Set for EMs Ex China
Outside of China, the number of listed stocks with greater than
$2 billion in market cap is compelling.
Sources: FactSet, MSCI, Bloomberg, Goldman Sachs Global Investment Research,
and William Blair, as of February 3, 2023.
1600
1400
1200
1000
800
600
400
200
0
United States
China A
EMs ex China
EU ex United Kingdom
Japan
China Offshore
United Kingdom
EXHIBIT 7
Attractive Fundamental Characteristics
EM ex China stocks have higher ROE.
MSCI EM IMI
MSCI EM ex
China IMI
Quality
ROE
16.26
18.49
Cash Flow ROIC
16.79
18.13
Debt-to-Equity Ratio
78.15
82.16
EPS: Long-Term Growth
13.84
12.88
EPS Growth: Five-Year Historic
11.1
9.54
Reinvestment Rate
11.51
12.1
Valuation
P/E Ratio
14.32
13.73
Dividend Yield
3.17
3.61
Sources: MSCI and William Blair, as of January 31, 2023. ROE refers to return on
equity. ROIC refers to return on invested capital. P/E ratio refers to price-to-
earnings ratio. EPS refers to earnings per share. Indices are unmanaged and do not
incur fees or expenses. A direct investment in an unmanaged index is not possible.
Meanwhile, quality characteristics of EMs ex China are
attractive, as illustrated by higher return on equity
(ROE) and cash flow return on invested capital (CFROIC)
for the MSCI EM ex China IMI versus the MSCI EM IMI.
In addition, while the MSCI EM ex China IMI’s historic
earnings per share (EPS) growth has lagged the broad
index including China, earnings growth expectations show
a marked improvement for the MSCI EM ex China IMI
and valuations are more attractive.
Not surprisingly, EM ex China companies are well
represented in our quality growth investment universe
(our eligibility list). Our eligibility list, as of January
2023, includes 48% EM stocks, of which 68% are EM ex
China names. That gives us approximately 650 EM ex
China names to draw from.
WILLIAM BLAIR INVESTMENT MANAGEMENT
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7
Emerging Markets—Beyond China
(continued)
What are attractive areas in EM ex China, in your view?
Romina:
EMs have experienced significant changes
over the past decade. Their key drivers are now largely
growth sectors, such as IT and consumer, reflecting
increased innovation and income growth and contrasting
with the largely dominating commodity plays of the past.
The changing face of EMs has been underpinned by a
surge of innovative, digitally enabled business models in
e-commerce, communications services, and fintech, to
name just a few areas. This phenomenon has been a key
development in China—but also outside of China.
So, IT is a key theme in EMs ex China (IT and tech-related
sectors account for 32% of the MSCI EM ex China IMI,
close to 37% of the MSCI USA IMI, and well ahead of other
developed markets, as exhibit 9 illustrates). Within IT,
EM ex China has a clear leadership in semiconductors and
hardware, which are export-oriented and driven by global
demand. In addition, financials are also a key sector; this
provides more domestic exposure.
From a geographic perspective, India is a key market
in the MSCI EM ex China IMI and a very attractive
opportunity set for us, as my colleague Casey Preyss
described in his blog post,
5 Growth Opportunities in India
.
Source: William Blair, as of January 2023. Regional breakdown based on the MSCI ACWI IMI.
EXHIBIT 9
Tech Market Share by Region Favors EMs
The changing face of EMs has been underpinned by a surge in innovative, digitally enabled business models combined with technological leadership in
hardware and semiconductors.
EXHIBIT 8
William Blair Global Team Eligibility List
EM ex China accounts for 33% of our global eligibility list.
Source: William Blair, as of January 2023. The 33% refers to 69% of 48%.
35%
30%
25%
20%
15%
10%
5%
0%
United States
Global EMs
Global EMs ex China
Japan
Continential Europe
United Kingdom
MSCI ACWI IMI
Media and Entertainment
Internet Retail
Semis
Software and Services
Tech Hardware
40%
48%
12%
EMs
EMs ex China
United States
China
Developed
Markets ex
United States
69%
31%
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EMERGING MARKETS—BEYOND CHINA
Emerging Markets—Beyond China
(continued)
Let
ʼs talk about the EM ex China Growth strategy. What is
the origin of this strategy and its design?
Romina:
Given the market and index developments;
conversations with clients and consultants; and an
analysis of our expertise, track record, and opportunity
set, we decided to launch our EM ex China Growth
strategy in 2021. We first launched a private fund vehicle
with seed money and sometime later launched a mutual
fund in collaboration with an existing client in our
broad EM Growth strategy.
The design of the strategy is similar to our long-
standing flagship EM Growth strategy. That strategy
offers broad exposure to high-quality growth names
across EMs (including frontier markets) and sectors,
and has a constant exposure to small-cap stocks.
We believe this breadth provides broad sources of alpha,
and is a differentiating feature of our EM ex China
Growth strategy.
In addition to having a similar design as our EM Growth
strategy, our EM ex China Growth strategy is managed by
the same portfolio managers as the EM Growth strategy:
Todd McClone, CFA, partner; Casey Preyss, CFA, partner;
and Vivian Lin Thurston, CFA, partner, which further
ensures consistency across these strategies.
Besides the China allocation, the main difference between
our EM Growth strategy and our EM ex China Growth
strategy is the number of holdings (typically 120 to 175 in
EM Growth versus 80 to 130 in EM ex China Growth)
and the maximum sector weighting (40% for EM Growth
and 50% for EM ex China Growth). This is designed to
reflect the opportunity set and larger IT weighting in the
MSCI EM ex China IMI.
Naturally, the overlap between our EM ex China Growth
and EM Growth strategies is typically high—greater
than 90% as of January 2023. It is important to highlight
that our EM ex China Growth strategy is actively managed
by the team as a standalone strategy (meaning it is not
an automatic carveout from our EM Growth strategy) and
it continuously reflects what the team believes are the
most attractive investment opportunities in EMs outside
of China. In managing the strategy, the team leverages
the full breadth of the team’s platform, including attractive
investment opportunities that are part of our EM Small
Cap Growth strategy. Individual stock weightings are the
result from conviction on fundamental thesis and portfolio
fit as well as stock liquidity and, to some extent, weightings
in the MSCI EM ex China IMI.
Sector, country, and market-cap positioning are generally
consistent with our EM Growth strategy, with the most
noticeable difference being a higher weighting in financials
and IT and a lower weighting in consumers and industrials.
Style exposure in our EM ex China Growth strategy is
consistent with all other EM strategies managed by the
team. They typically display higher-quality characteristics
and stronger growth than their respective benchmarks.
These attractive fundamental metrics typically result in
higher P/E multiples.
Is there any kind of negative screening for a company
that may be domiciled in, say, India but derives a large
component of its revenue from sales into China?
Romina:
We don’t look at geographic revenue to define
eligibility (or non-eligibility) for this strategy. Our EM
ex China Growth strategy does not invest in companies
that have their principal offices in the People’s Republic of
China (PRC). Mainland China, Hong Kong, and Macau are
included in the definition of PRC.
How do you think about Taiwan?
Romina:
That’s a fair question. In terms of the portfolio,
we aim to offer a strategy that can complement a China
allocation without missing any component of EMs.
Taiwan is a large market, representing 21% of the MSCI
EM ex China IMI, and it is also part of our EM ex China
Growth strategy.
Also, Taiwan, like South Korea, has a differentiated
profile and dynamics. It’s export-oriented, with a global
leading edge in semiconductor and IT more generally and
it is closer in many ways to a developed market than an
EM. This provides interesting opportunities and potential
diversification benefits within the EM universe.
WILLIAM BLAIR INVESTMENT MANAGEMENT
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9
Emerging Markets—Beyond China
(continued)
Sources: William Blair, as of January 31, 2023. The data shown above is based on each strateg y’s representative portfolio. Region and sector distribution are calculated in Eagle
based on Global Industry Classification Sectors (GICS). Small-cap is defined as $0 to $5 billion, mid-cap as $5 billion to $20 billion, and large-cap greater than $20 billion. Cash
is excluded. For informational purposes only and not intended as investment advice. Holdings are subject to change at any time.
Emerging Markets Growth
Emerging Markets ex China Growth
EXHIBIT 10
Portfolio Positioning
The sector, regional, and market-cap breakdown of our EM ex China Growth strategy compared to EM Growth strategy shows how the
strategies differ.
Regional Exposure
Market Capitalization
Sectoral Exposure
EM Asia
Communication Services
China
Discretionary
India
Staples
Korea
Energy
Ta i w a n
Financials
EMEA
Healthcare
Russia
Industrials
South Africa
Information Technology
Latin America
Materials
Brazil
Real Estate
Mexico
Utilities
78.7%
6.5%
2.4%
15.3%
8.2%
13.7%
9.5%
4.0%
4.0%
69.6%
27.9%
19.2%
25.0%
0.0%
7.0%
12.1%
12.9%
8.3%
2.2%
2.9%
2.4%
4.2%
13.1%
18.5%
8.5%
11.0%
3.4%
5.8%
10.7%
19.5%
20.6%
23.4%
5.7%
6.5%
8.9%
8.5%
20.5%
30.5%
2.7%
3.6%
1.9%
2.3%
0.3%
0.0%
0
10%
20%
30%
40%
50%
60%
Large
Mid
Small
54.8%
46.0%
21.1%
21.6%
24.1%
32.4%
10
|
EMERGING MARKETS—BEYOND CHINA
Emerging Markets—Beyond China
(continued)
From a cyclical perspective, we see clear signs of a
trough in the semiconductor cycle; with peak inventories,
we expect that trough valuations may lead the way to
sustained earnings and stock price recovery.
In terms of the geopolitical outlook for Taiwan given
heightened tensions with China, we think the near-term
risk of an escalation into a direct conflict between
China and Taiwan is low but not zero. My colleague,
Vivian Lin Thurston, talks about Taiwan more in a recent
blog post,
China: 5 Questions
. Rather than repeat her,
I refer readers there.
How are you addressing environmental, social, and
governance (ESG) considerations in the new strategy?
Romina:
ESG is integrated the same way it is for all of
our global equity strategies. Our focus is on financial
materiality based on our proprietary materiality frame-
work for each industry. We also prioritize engagement,
which we believe is particularly important in EMs and with
smaller companies. The team has significant expertise
researching and engaging with senior management and
board members of small- and mid-cap companies at
earlier stages of the corporate lifecycle. As we engage with
these companies, especially in EMs, we have a greater
appreciation for the impact we can have as corporate
governance practices are still evolving (and so are local
governance codes), and many companies have yet to
formalize their sustainability priorities and goals. This
necessitates a pragmatic approach to our analysis and
engagement methods.
Will the strategy appeal to more ESG-motivated
investors who see China as having a poor record in
regard to ESG?
Romina:
That’s a good question. Certainly, by excluding
China, you’re not getting the geopolitical or ESG risks
that surround China. But we’re not demonizing China.
There are many similar issues across EMs. Investing
in EMs carries its own ESG risk, and we believe the
solution is to choose a manager with a clear lens into
ESG considerations. It’s about how we select companies.
And, as I noted above, ESG is integrated into our EM
ex China Growth strategy with a pragmatic approach,
understanding the geographic and corporate lifecycle
nuances and focus on materiality.
“Our EM ex China Growth
strategy allows investors to have a
deeper exposure to EM investment
opportunities and complement
a China allocation, including a
zero allocation.
”
Romina Graiver, Partner
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The
MSCI All Country World Index (ACWI)
and the
MSCI All Country World Index (ACWI) Investable Market Index (IMI)
capture large- and mid-cap representation
across 23 developed markets and 24 EMs. The latter is broader, with a larger number of securities. The
MSCI China Index
captures large- and mid-cap representation across
China A shares, H shares, B shares, Red chips, and P chips. The
MSCI Emerging Markets (EM) Index
captures large- and mid-cap representation across 24 EMs. The
MSCI
Emerging Markets (EM) ex China Index
captures large- and mid-cap representation across 23 of 24 EM countries excluding China. The
MSCI Emerging Markets (EM)
Investable Market Index (IMI)
captures large-, mid- and small-cap representation across 27 EMs; the
MSCI EM ex China Investable Market Index (IMI)
excludes China.
The
MSCI USA Investable Market Index (IMI)
is designed to measure the performance of the large-, mid-, and small-cap segments of the U.S. market. The
MSCI World Index
captures large- and mid-cap representation across 23 developed markets.
Cash flow return on invested capital (ROIC)
is a measure of how effectively a company generates cash flow based on capital investment.
EPS: long-term growth
represents
the weighted average of forecasted growth in earnings expected to be experienced by stocks over the next three to five years.
EPS growth: five-year historic
reflects the weighted
average earnings per share growth for stocks over the past five years.
P/ E r a t i o
is the ratio of a stock’s current price to its per-share earnings over the past year.
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Copyright © 2023 William Blair. “William Blair” refers to William Blair & Company, L.L.C., William Blair Investment Management, LLC, and affiliates. William Blair is a
registered trademark of William Blair & Company, L .L .C.
16442736 (03/23)
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