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Looking to Trim Your Exposure to China?

Traditional emerging markets benchmarks are being strained this year by slumping Chinese stocks – a scenario caused by Beijing’s intensifying regulatory efforts toward consumer internet and for-profit tutoring firms, among others.

The MSCI Emerging Markets Index is down 0.79% year-to-date, indicating it’s hardly worth the trouble when the S&P 500 is higher by 19.55%. Yet that doesn’t mean all emerging markets stocks are duds this year. Rather, the MSCI Emerging Markets Index’s 2021 slump is a reflection of a large weight (more than a third) to Chinese stocks.

Advisors can do better with the WisdomTree EM Factor Portfolio. This model portfolio is home to five exchange traded funds, several of which significantly dial back China exposure relative to old-guard emerging markets benchmarks. That’s constructive because the case for equities in developing economies is far from dead.

“While we are bearish on Chinese equities for US investors, we are bullish on EM broadly and on India in particular. For the long term, these economies benefit from favorable demographics, modernization potential, and generally attractive valuations. For the short term, they benefit from a trade rebound, a weaker USD, and easy global monetary policy,” said Bank of America analysts in a recent note.

Access to Developing Economies

The WisdomTree model portfolio is relevant at a time when developing economies, broadly speaking, are still delivering strong rates of growth. Many U.S. investors also don’t maintain significant exposure to this asset class.

“Emerging markets ex-China (EMxC) will contribute nearly a third of 2022 global GDP growth ($21.2tn of $93.8tn, per the IMF). Yet their allocation is very small in most portfolios, representing just 12% of global equity market capitalization. We expect this allocation to rise in coming years,” according to Bank of America.

As for members of the model portfolio that dial back China exposure, the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS) is a good place to start. DGS has a weight of just 13.41% to Chinese stocks, ranking the country third among the ETF’s geographic exposures. With a dividend stream to buffer volatility and cyclical sector exposures, DGS is relevant as emerging economies beyond China get back on track.

Additionally, the more investors focus on emerging markets ex-China, the more they could be rewarded on valuation.

“Since April, profit expectations between EM (including China and EMxC have diverged. The consensus forecast is for 55% EPS growth over the next 12 months for EMxC, vs. just 36% including China,” adds Bank of America.

For more on how to implement model portfolios, visit our Model Portfolio Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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