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The merits of a stand alone equity allocation to China

October 26, 2021

In this paper, we explore why accessing China via global or emerging market (EM) strategies will likely dilute the alpha potential.

A standalone equity allocation to China offers compelling diversification and excess return benefits for those with the ability to take advantage of this exciting opportunity set. In recent times many institutions have looked to access China via global or emerging market (EM) strategies. However, this approach will likely dilute the alpha potential and is not our preferred route.

Size and scale worthy of a standalone allocation

China is the second largest economy in the world, about 66% the size of the US, and contributing about 16% of global GDP in 20181. Its equity market is the world’s second largest by market capitalization, offering substantial breadth and depth in terms of the variety of listed companies and sector exposures, and it offers good liquidity potential. Despite this scale and breadth, China is underrepresented in most global investment portfolios.

According to a recent survey undertaken by Greenwich associates2, pension funds and endowments have between 3% and 5% allocations to China, with European asset owners typically having less exposure than those surveyed who are based in North America. The authors of the survey go on to say that just 14% of asset owners globally, by number, and just 5% of North American institutions have any dedicated exposure to China’s equity markets.

Why is the exposure to China so low?

Historically, the simple answer was that Chinese capital markets were closed to foreign investors. However, once they became more accessible investors were still reluctant to make explicit allocations. Some investors were of the view that because onshore China was not part of the standard global equity market indices (which are used to measure global equity portfolio performance) they simply did not need to make an allocation. Others, who could see the potential opportunity, preferred instead to give their EM or global equity managers an allowance to invest a portion of their portfolios in China. Further, given the relatively immature state of the onshore market, many were worried about finding high quality institutional grade managers that would meet their due diligence standards.

Today, China accounts for about 5% of the MSCI All Country World Index. For those anchored to indices, this suggests little need for a standalone allocation. By way of comparison, the US accounts for 55% of the Index. That said, this is backward looking. We know the major index providers will substantially increase the allocation to China over the next 10 years.

When other countries entered such indices, there was a marked increase in foreign participation and investment flows. In our mind, it is better to be positioned ahead of this trend.

Read our The merits of a standalone equity allocation to China paper where we explore the diversification benefits for standalone equity allocation to China, what are the Alpha opportunities, what are the typical investment approaches, and how investors should position their portfolios.


1 Source: International Monetary Fund (IMF), Organisation for Economic Cooperation and Development (OECD)

2 Please refer to “Crafting the optimal China allocation strategy, The asset owner’s perspective, Q2 2020” by Greenwich Associates and Matthews Asia

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