- The US and China have struck a trade deal after negotiations in London, according to reports
- Reforms to China’s property and manufacturing sectors over the last 10 years have had a profound impact for investors
- How has AJ Bell’s EM ex-China allocation played out since the turn of the year?
James Flintoft, head of investment solutions at AJ Bell, comments:
“Amid news the US and China finally managed to broker a deal resembling temporary trade peace in London, investors will undoubtedly be turning to their portfolios to assess the damage of the last six months and where their exposure to China has left them since President Trump’s inauguration and subsequent tariff wars.
“US-Chinese trade relations were shaky before Donald Trump unveiled his whiteboard of ‘reciprocal tariffs’ on the White House lawn on 2 April, but it’s worth looking back a bit further to fully appreciate the position Chinese markets find themselves in today.
“It’s been a turbulent decade for the world’s second biggest economy, with equally varying market performance during that time.
“Ten years ago, China launched an industrial strategy to upgrade to a high-tech industrial base called ‘Made in China 2025.’ Little did they know it would be finalised in a year when their main economic rival would attempt to definitively pivot towards protectionism.
“Perhaps the authorities anticipated the struggles they would experience in shifting economic growth from a reliance on the property sector, and the uncomfortable comparisons that would bring with Japan’s lost decades.
“For equity investors, the reforms to the property sector have had a profound impact, compounded by the first trade war and a crackdown on the freedom of technology companies.
“The main Chinese equity indices are lower over the past five years to the end of May. Amid so much negative sentiment in early 2024, index valuations, as measured by the forward P/E, dropped to 20-30% of their post-Global Financial Crisis (GFC) averages (between 1 January 2010 and 31 December 2023).
“Government initiatives in the second half of the year unleashed an almighty rebound, with some indices rising over 30% in a matter of days. Expectations of earnings upgrades compounded upon the low starting valuation. The rally cooled as the year end approached, however 2025 has seen a similarly dramatic performance, albeit this time with differentiation.
“The release of the DeepSeek AI model inJanuary was a definitive moment, challenging the prevailing wisdom that US companies would dominate the AI space. This set in motion another ferocious rise in large cap H shares (these are shares traded on the Hong Kong stock exchange).
“In times of divergence in markets, strategic asset allocation decisions, such as benchmark selection, can show up in unexpected ways for those unaware of the nuances.
“The broadest definition of China (Greater China) includes Hong Kong and Taiwan. Over the past three years it has paid to invest in the MSCI Greater China index, or strategies that manage around it, because it has a large allocation to TSMC and hence rode the dominant tech/AI theme in wider markets.
“If on the other hand someone specifically targeted A shares (shares that trade on the mainland Chinese stock exchange), they will have missed out on this trend and the 2025 H share rally too.
“The MSCI and FTSE Greater China indices meanwhile has had the H share gains this year eroded by exposure to the wider tech sector, namely TSMC and its close association with the US AI champions.
Source: Morningstar
“That is where slightly broader China indices come in handy, such as MSCI China. This index does not include Hong Kong and Taiwan, but does target an A share component, alongside H shares, P chips (offshore companies that trade on the Hong Kong stock exchange) and Red chips (state owned companies that trade on the Hong Kong stock exchange). A shares are capped by index inclusion criteria and inclusion ratios.
“Failing to assess the underlying positions of a passive or active holding with respect to these differences may have seen a few investors surprised with how their portfolios have performed this year.
“Turning to where we stand today, there has been a rerating, meaning valuations across China equity indices sit much closer to the post-GFC averages. In other words, the easy money has been made, especially when you consider the relative performance to US equities.”
Revisiting AJ Bell Investments’ Chinese allocation
“China is still on the cheap end of the spectrum when looking across other regions. The shift in narrative around AI and the benefits of Made in China 2025, which now means manufacturing in China is not all about cost, could be felt for some time.
“Of course, other factors explain some of the valuation discount. The elephant in the room is Taiwan. Most are aware of the invasion risk, but it is unpredictable.
“There are different approaches to these types of risk. Perma-bear investors can be very well appraised of the minutiae of risks but can also miss out on opportunities whilst believing they hold the intellectual high ground. Others, meanwhile, may continue investing without fully appreciating their exposure, until it matters.
“AJ Bell’s Investment team adopts a more nuanced approach: recognising both the opportunities in China and the risks that may require careful management. That’s why in 2025 we moved our asset allocation to an Emerging Markets ex-China model, with dedicated allocations to China that allow for quick and efficient changes to exposure should we need to be agile.
“For many this was a pressing issue when China accounted for over 40% of the MSCI Emerging Market index back in 2020, but it remains an obvious risk management improvement that allocators can make to their processes.”