Getting Granular with Emerging-Market Allocations
Investors with allocations in emerging markets (EM) may have noticed that the correlation between China and EM ex-China has declined sharply over the last five years. Through the 2010s, the three-year rolling correlation hovered above 0.8, but correlations are now at their lowest in more than two decades, sitting below 0.4 as of the end of May. This decoupling underpins the reason that many investors are increasingly looking to treat China and EM ex China as separate building blocks in portfolio construction, as we examined in Rethinking EM Equity Investing as EM ex China and China Diverge.
The efficient-frontier chart below indicates how different allocation mixes between China and EM ex-China influenced portfolio outcomes. Each point on the curve represents a fixed-allocation mix between the two while the red dot represents the historical performance of the MSCI Emerging Markets Index. The blue curve shows that as we reduced the allocation to China and increased exposure to EM ex-China, we achieved higher returns for lower or similar levels of volatility. The portfolio with 80% allocated to EM ex China lies above the MSCI EM Index, implying superior portfolio efficiency from a risk-adjusted-return perspective. Using a correlation matrix based on last three years of returns helps shift the efficient frontier further to the left, highlighting stronger diversification benefits and lower portfolio risk for a given level of expected return.
This outcome reflects the lower correlation between China and EM ex China observed over time. While the analysis is grounded in historical performance and captures two decades of market behavior, it is important to recognize that correlations, volatility and return drivers can shift as market dynamics evolve — something to keep in mind as investors investigate their EM allocations.
Chart shows the rolling 36-month correlations between monthly returns of the MSCI China and MSCI Emerging Markets ex China Indexes from Dec. 29, 2000, to May 29, 2025.
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Rethinking EM Equity Investing as EM ex-China and China Diverge
With global economic divergence persisting, more asset owners and asset managers are addressing the increasing heterogeneity within emerging markets (EM) by carving out China from EM allocations. We explore the rationale and its implications.
MSCI Emerging Markets ex China Index
The MSCI Emerging Markets ex China Index captures large and mid cap representation across Emerging Markets (EM) countries excluding China. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
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