China allocation debate heats up among emerging market fund managers
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on Emerging Markets and the sectors and countries within the asset class.
The debate over China's place in emerging market portfolios among institutional investors has shifted from whether to reduce exposure to how much risk investors are willing to stomach for single-digit valuations and large dividend yields.
Five years ago, China represented roughly 42 per cent of the MSCI Emerging Markets Index. But that number has since changed shape, particularly as Taiwan's weight has climbed on the back of TSMC's surge, while mainland China's standalone allocation has dropped.
Yet while many large global managers have trimmed their China positions in step with the index, some continue to see China’s potential.
“We have not done that because we are able to spot a lot of good investments in China," said Rohit Khuller, vice president, investment management and senior partner at Letko Brosseau. "Investments where if you compare them with some of their peers in US and Europe, they would be trading at three or four times the valuation of what the Chinese business is trading at. Because these companies in China are paying you a strong dividend yield, which is likely to be sticky, in fact it may even grow, we expect a lot of our investments in China will grow their dividends in the future.”
Chinese dividend growth anchors emerging market case
Khuller acknowledged that the valuation gap is one part of the case while the other is income. Khuller's Chinese holdings pay an average dividend yield of six to seven per cent, and he expects those payouts to grow. For a portfolio targeting 15 per cent annual returns, dividends alone cover more than a third of that hurdle before any capital appreciation.
Moreover, Khuller emphasized how China's GDP growth has decelerated after decades of high single-digit and low double-digit expansion, but he sees that as a natural maturation rather than a red flag. With GDP per capita now around $15,000, according to 2026 International Monetary Fund projections, he underscored that slower growth was inevitable. According to Khuller, Letko Brosseau still projects three to four per cent annual growth over the next few years, a rate he considers healthy for an economy of China's size.
Chinese consumer economy looks ‘weak and deflationary’
But China's consumer economy tells a different story, and Michael Mortimore, client relationship manager at NS Partners, is less willing to look past it.
"Consumer demand and consumer sentiment looks incredibly weak and deflationary," he said, noting that while China's late-2024 stimulus triggered a brief rally in consumer stocks, the momentum faded fast and conviction that Beijing will stand behind household spending has eroded.
Khuller acknowledged the same drag, noting retail sales growth through the first five months of 2025 came in at just 1.4 per cent year over year, according to China's National Bureau of Statistics. The culprit, he suggests, is the property market as Khuller noted Chinese households have historically parked 70 to 80 per cent of their savings in real estate, and the prolonged downturn has crushed spending power.
Additionally, Mortimore noted how property prices have roughly halved from their peaks across most of the country outside Beijing and Shanghai, dragging consumer sentiment down with them. The state, meanwhile, has directed its support to the nation’s innovation base and strategic industries - battery technology, robotics, advanced industrials, chip packaging - where it wants self-sufficiency.
That split has shaped how Mortimore's team is positioned.
"We've been leaning heavily into industries which are strategically very important to the state and really being quite heavily underweight consumers, it just looks like we're in this sort of disinflationary, deflationary funk," he said. “We've been really selective in China.”
Yet, Khuller sees China's innovation base as enough to sustain three to four per cent GDP growth and to generate attractive bottom-up opportunities regardless of the macro headwinds.
"I don't see why you need to reduce your allocation to companies that are growing their dividends and are trading at five- or six-times earnings," he said.
Still, Mortimore is less optimistic about the outlook.
“I think one big potential loser is China,” he said, noting China's manufacturing base is producing far more than domestic consumption can absorb, and the surplus is spilling into global markets. He pointed to the auto sector as one clear example, highlighting Volkswagen's plan to cut 100,000 jobs signals the kind of competitive pressure that tends to provoke a political response.
Meanwhile, the United States has already moved to erect trade barriers, and Mortimore expects Europe and others to follow.
Why China needs to reinvigorate domestic demand
"China is dumping its excess capacity on the shores of Europe," he said. "I don't think it's being too glib to suggest that there'll be repercussions with other countries being forced to act. Otherwise, they'll be sitting back and watching as their own countries or economies are deindustrialized."
The problem compounds on itself, Mortimore suggests. Shut out of the US market, Chinese exporters redirect volume to Europe, Southeast Asia, Japan, and Korea - countries already competing with China across overlapping industries. Europe faces a particular bind, since China is also one of the largest export markets for many European companies.
"If China was able to reinvigorate domestic demand and also curb the incentives that basically fuel all this excess capacity, we think that that would be a really, really positive development and really bullish for long term prospects for China as a whole and the sustainability of its economic model," he said.
Without that shift, the cycle of overcapacity, trade friction, and weakening consumer spending risks becoming self-reinforcing, Mortimore suggests. Not just for China's own economic model, but for the countries forced to absorb the fallout.
Chinese healthcare stocks offer investment opportunities
Still, Khuller remains firm in his position, noting that China's aging population, with a median age close to 41 and rising, is creating structural demand for healthcare infrastructure, from hospitals and medical devices to pharmaceutical distribution.
The country has also moved toward universalization of healthcare, opening another revenue channel for companies in the sector.
Two names also anchor his China exposure. Sinopharm, the country's largest drug distributor, functions as a mainland equivalent of McKesson. Shandong Weigao is one of the largest medical device manufacturers in China, producing syringes, catheters, infusion sets, and orthopedic products. Both trade between six- and eight-times earnings and return five to six per cent annually through dividends.
"We actually like China here, it's beaten down and you've got fantastic businesses," he said.
According to Khuller, the team takes an active approach, screening for competitive businesses and low-cost producers, paying little attention to index composition.
That said, the macro work is not optional, he emphasized, as currency depreciation, inflation trends, interest rates, and purchasing power parity all feed into the process, and the goal being to avoid getting trapped in a country where the macro erodes whatever the micro delivers.
"We like to build a portfolio bottom up rather than top down but that doesn't mean you're going to ignore the macro because macro is also very important," he said.
