China has fallen out of favor over the past several years. The market suffered double-digit losses in 2021, 2022, and 2023; the economy has slowed; and political tensions have grown between that country and the United States. The tariff situation has only added to the uncertain outlook for China’s equity market.

Avoiding China paid off over the most recent five-year period, as returns have been roughly flat overall. But is there a more fundamental reason to exclude China from an otherwise globally diversified portfolio? In this article, I’ll look at some of the pros and cons of Chinese equities from a portfolio perspective.

Part 1: The Case for China

One argument in favor of including China exposure is the country’s sheer size. China accounts for roughly 17% of the global population and 19% of global gross domestic product. Based on market capitalization, it currently accounts for about 28% of the MSCI EM Index, up from about 3% in 2003.

China’s equity market has also generated strong returns at times. The market surged ahead from 2001 through 2007, driven by robust economic growth, an increase in foreign direct investment, and a rise in global exports. China was hit hard during the global financial crisis but bounced sharply with a 60%-plus gain in 2009. As shown in the chart below, returns were also relatively strong over most of the period from 2010 through 2019.

China vs. Broader Emerging-Markets Index: Rolling Three-Year Returns

In addition, stocks in China typically don’t move in tandem with other major equity markets, which makes them valuable from a diversification perspective. Over the trailing three-year period through May 2025, China’s equity market has had a correlation coefficient of just 0.12 when measured against the Morningstar US Market Index, compared with about 0.6 for the broader emerging market benchmark. That’s a much lower correlation than that of most other major markets. The upshot: Including an allocation to China could improve a portfolio’s risk-adjusted returns.

Part 2: The Case for Excluding China

What are the key reasons not to invest in China? For one, simply having a large population and a growing economy doesn’t necessarily mean more money in shareholders’ pockets. As detailed in a 2019 article by Aoris Investment Management, “The Emerging Market Fallacy,” earnings per share growth in emerging markets has fallen well short of GDP growth.

That’s particularly true for China, where state-owned enterprises remain prevalent. While less than a third of listed firms in China are state-owned, those companies account for a large percentage of the market based on market cap, revenue, and earnings. Related-party transactions, insider trading, questionable capital allocations, and complex ties between politicians and management teams have all been long-standing concerns.

While the country has made some market-based reforms and significantly improved shareholder rights with the Company Law that went into effect in July 2024, some problems remain with transparency and investor protection. And given the fundamental conflict between the rights of the shareholder and the nature of a socialist economy, it’s not clear if shareholders in Chinese firms will ever enjoy the same level of protection as they do in other markets. More broadly, the Chinese government retains significant power to enforce laws and make sweeping regulatory changes that can destroy shareholder value.

There’s some evidence that countries with greater respect for shareholder rights and the rule of law have generated better returns over time. That’s the animating principle behind the US listed Freedom 100 Emerging Markets ETF FRDM, which excludes stocks from countries such as China and India and also avoids purchasing shares in companies that are state-owned enterprises. Over the past five years, the fund’s performance has landed in the top 5% of the diversified emerging-markets category.

Avoiding equities based in China would have also paid off over longer periods. Over the period starting in 1993, for example, a hypothetical $10,000 investment in the MSCI China Index would have grown to about $16,400, compared with about $88,000 for the MSCI EM Index.

Stocks based in China may or may not lag going forward, but their lackluster long-term returns to date don’t inspire too much confidence.