Emerging markets investors assume political and governance risks, most notably from the high concentration of Chinese stocks in emerging markets indices in recent years However, the growth of Taiwan’s semiconductor industry and the emergence of India as a strong competitor to China are diversifying the China concentration in developing market indices.
In 2020, China’s outsized influence on the investable emerging markets peaked, when Chinese companies comprised over 40%of the index. This high concentration in Chinese stocks created a difficult decision for investors. On one hand, China was a high-growth economy responsible for almost 20% of global GDP. On the other hand, investors in China assumed additional risks due to the authoritarian communist government, including poor corporate transparency and governance, serious demographic challenges, human rights concerns, and uncertain property rights for foreign investors. The government’s influence over the stock market was demonstrated positively for investors this month, as Beijing enacted aggressive stimulus measures that drove Chinese stock prices higher.
India is not an investor’s panacea, but the country has fewer structural deficiencies than China. While not fully up to developed market standards, India is a democratic nation with a common law legal system, which gives Western investors more confidence around government and corporate governance issues. India’s population is relatively young and growing, unlike China’s aging demographic. However, India is not without risks. Some additional caveats to consider are that Indian stocks appear expensively valued based on earnings multiples, India has a high degree of income inequality, and the country is heavily reliant on imported energy.
The volatility of emerging markets creates an environment of dynamic risks, where risk exposures can change dramatically. Of late, China-specific risks in emerging markets have been declining, while exposure to India and to Taiwan’s semiconductor industry are increasingly prevalent in the index.