China or India: which is the best emerging market to own in 2023?

With nearly three billion people between them, India and China are too big to ignore. But which will make the best investment?

India and China are the two giants of emerging market investing – but have different economies, stock markets and return prospects.

Each with 1.4 billion people, and more than $20 trillion ($17.7 trillion for China and $3.2 trillion for India) between them in gross domestic product, they are impossible to ignore and heavily influenced by investor sentiment.  

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Until November last year, the MSCI India index had returned around 10%, while the MSCI China index had fallen 30%. However, since November the tables have turned. Chinese shares have risen 32% and Indian shares have fallen 7.5%.

Recent performance means that Chinese shares are far cheaper than Indian shares relative to their earnings, with a price-to-earnings ratio of 14.5 on the MSCI China index compared with 26 on the MSCI India index, as of the end of 2022. 

So, what is the outlook for the different markets, and where are professional emerging market fund managers putting their money?

China forecast to bounce back

China is expected to perform much better than this year, and has already made an excellent start to the year after finishing 2022 strongly. The MSCI China index has risen 15% so far in 2023. 

Lisa Shalett, chief investment officer Morgan Stanley Wealth Management, expects a more “pro-growth, stimulus-oriented stance” with the Chinese Communist Party prioritising economic development over goals related to security and social stability.

“We also see a possible end to China’s zero-Covid policy by the new fiscal year in April 2023. A full re-opening could allow private consumption to rebound substantially and boost China’s inflation-adjusted GDP growth from below 3% to 4.5% in 2023.

“Importantly, as China pursued a very different policy response to Covid from most of the West, it is not experiencing high inflation or rising interest rates. This gives Beijing significant runway for stimulus,” she said.

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Tom Wilson, head of emerging market equities at fund manager Schroders, also sees big potential for a rebound in Chinese shares this year. He says there could be a “cyclical recovery” as the economy recovers from zero-Covid policies.

“China now appears to be moving to an endemic approach to managing the virus. New domestically delivered vaccines support a renewed push on vaccine penetration. A move to an endemic state will bring fresh ‘exit’ waves of the virus, but will significantly reduce the risk of persistent macro pressure,” he said.

However, Wilson says that headwinds remain, as slowing global growth could weigh on Chinese exports in 2023 and a move to more tolerance of Covid will bring fresh waves of the virus, which may slow the economy down until herd immunity is established.

The biggest pushback against owning Chinese shares is not that the shares are not good value nor whether there are not ample growth opportunities, but that state intervention in the private sector is a threat that is simply too great.

Another, more terrifying potential risk, is that China would be emboldened to attack Taiwan.

Chetan Sehgal, manager of the Templeton Emerging Markets Investment Trust (TEMIT), is another optimist. He says there are now opportunities in China, especially in businesses that are aligned with the strategic priorities of the Chinese Communist Party, such as renewable energy and the electric-vehicle supply chain.

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Addressing geopolitical tensions, Sehgal noted: “We’ll find out more about the country’s economic policies at the National People’s Congress in March, but our outlook for China remains constructive and we hope it could weigh in on long-term peace across the Taiwan Strait.”

TEMIT has 27.4% invested in China compared with 30.4% for the benchmark, and 12.3% invested in India compared with 14.8% for its benchmark. Its biggest positions in China are internet giants Alibaba (SEHK:9988) and Tencent (SEHK:700), as of the end of 2022. 

However, adopting more of a pessimistic stance towards China is Doug Ledingham, manager of the ACE 40-rated Pacific Assets investment trust. The portfolio has 45% invested in India and just 9% in China. He says that China does not have enough “investable” companies due to state interference and weak rights for foreign shareholders.

Ledingham said: “When it comes to China, we've long struggled to build an extensive list of investable companies because of their inability to meet our quality threshold. We've never owned the Chinese internet companies because we struggled with the quality of people. We've struggled with the corporate structures that meant that minority shareholders didn't own the underlying business.

“We struggled with the financials, and we struggled to understand how these companies were aligned with the Chinese Communist Party longer term, as it became increasingly dominant in all parts of the economy.”

He says that when the trust does invest in China, it is in companies that operate as far away from the state as possible, such as those run by private entrepreneurs rather than state-backed companies.

Ledingham points out that one option to get access to the emerging Chinese middle class is via companies that have operations in China – but are not Chinese.

Pacific Assets Trust owns Hoya, a Japanese firm that is a leading manufacturer of semiconductor equipment, as well as the second-largest manufacturer for lenses and eyeglasses.

China has an epidemic when it comes to short-sightedness, so Ledingham believes Hoya is perfectly positioned to enjoy not only structural growth in its profits, but also solve a major societal issue in China.

What about India?

Sehgal is also optimistic about India. He says its economic growth trajectory is forecast to outpace all emerging and developed economies in 2023, with an IMF estimate of 6.1% versus 4.4% for China, 1% for the US and 0.5% for the euro area.

“India’s growth in 2023 and beyond is expected to be robust, with several catalysts such as the rise of the middle class, a potential manufacturing boom and demand for talent in the IT sector. Indian equities will likely continue to outperform other emerging markets amid expectations for continued strong economic growth,” he said. His largest Indian position is ICICI Bank (NYSE:IBN).

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Ledingham is much more bullish on India than China due to the quality of the companies he finds in the market.

He said: “India is home to some of the greatest opportunities for long-term capital growth. It's home in our eyes to some of the world's greatest owners of companies, some of the highest-quality, most interesting franchises and home to markets that have the ability to offer decades’ worth of growth thanks to a growing middle class, increasing technological adoption, increasing financial penetration, and India's emergence as a manufacturing hub.”

One company he likes is industrial conglomerate Mahindra & Mahindra. It's been around since the 1940s, is family owned and has a professional CEO, which Ledingham says gives it a combination of a long-term steward with highly competent professional management.

He said: “It's been a great performer for the company to date on account of growing evidence of both its restructuring and knockout sales from its tractor franchise, as well as the release of its new line of electric vehicles.”

Another is HDFC Bank, the leading mortgage provider in India. Trading near all-time lows, its mortgage book is valued at a level similar to its European or US contemporaries, despite quality that is far superior and the ability to benefit from growing mortgage penetration, according to Ledingham

“Mortgage penetration as a percentage of GDP in India is less than 10% versus the 65% or 70% that we see in much of the developed European markets,” he says.

Which funds to buy?

Pacific Assets Trust is recommended on interactive investor’s list of ACE 40 sustainable investment ideas, and has a strong long-run performance helped by its overweight to Indian shares. The investment trust has returned 45% over the past five years compared with a 11% return for its benchmark, the MSCI Emerging Markets ex-Japan index.

interactive investor also recommends JPMorgan Emerging Markets. This investment trust has returned 37% over the past five years, versus just 6% for the MSCI Emerging Markets index. Investing more in India, at currently 22.5% of the portfolio compared with 15% for its benchmark, has been a key reason for its success. But this trust does not shun China. It has 21.7% invested there compared with 28.4% for its benchmark.

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Taking the open-ended emerging market fund universe, the funds with the most invested in China, according to data firm Morningstar as of the end of 2022, are Vontobel Sustainable Emerging Market Leaders (43%); Redwheel Global Emerging Markets (39%); and Artemis SmartGARP Global Emerging Markets Equity (37%).

The funds with the most invested in India, and which are available on the interactive investor platform, are: Aubrey Global Emerging Markets Opportunities Fund (41%); GQG Partners Emerging Markets Equity Fund (31%); and Carmignac Portfolio Emerging Discovery (28%).

There also specialist funds for investors looking to own just Chinese or Indian shares. Super 60 member Fidelity China Special Situations is an option for China fans, while there are four India-only investment trusts: India Capital Growth, JPMorgan India, Ashoka India Equity Investment Trust, and Aberdeen New India Investment Trust.