A New Era of Diversification: Emerging Markets ex-China
Authors & Contributors
Although China has historically been a dominant player in the MSCI Emerging Markets Index, investors are increasingly diversifying their portfolios as China's weight in the index has decreased to around 30%.
Cumulative Performance of MSCI China versus MSCI Emerging Markets Index ex-China
In the world of investing, where diversification is key to success, the old adage ‘don’t put all your eggs in one basket’ has recently taken on a newfound sense of urgency.
Over time, certain countries or companies can grow to dominate index composition, concentrating both performance and risk. For example, a group of seven large-cap US technology stocks, often referred to as the Magnificent 71, have driven a substantial portion of S&P 500® returns in recent years. Meanwhile, for Emerging Markets (EM) investors, China represented over 40% of the MSCI Emerging Markets Index at its peak, significantly influencing its trajectory.
This concentration dynamic presents opportunities for investors to consider alternative indexes designed to limit or exclude dominant exposures. Strategies such as MSCI ACWI ex-US, MSCI Emerging Markets ex-China or equal-weighted versions of traditional benchmarks offer some potential solutions. These approaches may deliver comparable long-term returns while potentially reducing volatility and idiosyncratic risks tied to a narrow set of countries or companies—particularly during periods when dominant constituents underperform or face structural challenges. The MSCI Emerging Markets ex-China may help address some of these concerns for emerging markets investors.
China’s path to an index heavyweight took decades to play out. It began in September 1996, when China was first included in the MSCI Emerging Markets Index with an initial weight of just 0.46%. Over the following two decades, its representation expanded as the country implemented reforms to open its capital markets, including the Qualified Foreign Institutional Investor (QFII) program in 2002 and the Stock Connect program in 2014. China reached a major milestone in 2018 with the phased inclusion of A-shares. These developments propelled China’s weight in the index to over 40% by September 2020, during the early stages of the COVID-19 pandemic. However, its share has since declined to settle around 30%, due to sustained underperformance and growing investor caution. China now faces a range of macroeconomic headwinds, including a prolonged property sector downturn, sluggish domestic demand and rising external pressures from geopolitical tensions and increasingly protectionist trade policies.
Weight of China in MSCI Emerging Markets Index vs Rest of Index
As a result, investor interest in emerging market equity strategies that exclude China has grown. As shown in the chart below, Chinese equities outperformed other emerging markets beginning in 2014, driven by reforms that improved foreign investor access. However, the post-pandemic environment has seen a reversal of this trend, as investors increasingly prioritize diversification, seek markets with stronger growth prospects and aim to reduce exposures to ongoing geopolitical tensions.
Cumulative Performance of MSCI Emerging Markets Index With and Without China
While past performance is no guarantee of future results, as discussed in our previous Macro Minute, “India’s Rise to Prominence”, the narrowing growth differential between China and the rest of the MSCI Emerging Markets Index suggests that investors may achieve similar performance with lower volatility by reducing China exposure.
1The Magnificent 7 stocks (Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla) are seven high-performing companies that significantly influence the stock market and represent a large portion of major indexes like the S&P 500.
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