For much of the last two decades, China has been the undisputed elephant in the room in emerging markets (EM). Its sheer scale has meant that shifts in Chinese policy, growth or sentiment have tended to dictate returns across the broad MSCI EM Index, for better or worse. But all that’s changing – and quickly.
As at 14 April 2026, Taiwan accounts for 23.5% of the index, almost level with China’s 23.7%*. Five years ago, China represented roughly 42% of the index. This shift isn’t a cyclical rotation but a profound structural reordering of the EM equity universe, driven by China’s persistent de-rating and Taiwan’s AI-led outperformance.
If current trends continue, it’s only a matter of time before Taiwan overtakes China.
Why China’s index weight has fallen
China’s declining index weight reflects persistent structural challenges, not short term economic headwinds. And those challenges stem from a combination of regulatory uncertainty, less robust governance and China’s troubling legacy of “involution”. Originally used to describe unproductive academic competition, involution is the now-ubiquitous Chinese label for intense rivalry that destroys economic value instead of creating it.
In the Chinese economic context, involution manifests itself as hyper competitive markets where companies compete relentlessly on price and volumes, profit margins collapse and returns deteriorate, yet capacity continues to expand.
Involution is deeply embedded in many different Chinese industries and sectors. Electric vehicles, solar panels, e commerce platforms and robotics all display similar characteristics: aggressive price wars, overcapacity, falling profitability and weak capital discipline. Investors are understandably reluctant to pay for growth when profit margins compress faster than revenues rise.
Repeated regulatory shocks and unpredictable policy settings have increased the risk premia applied to Chinese equities. Resistance to letting firms fail remains a key issue: local governments are still propping up zombie companies to protect employment, GDP targets and their own equity stakes. Genuine ‘creative destruction’ is rare, prolonging excess capacity and depressing returns.
All this feeds directly into MSCI index construction. The nominal size of China’s equity market is still vast. But the country’s free-float market weights in the key MSCI EM Index are increasingly curtailed as profitability, governance and investor confidence weaken. In short, China’s winners just haven’t been winning by enough.
Beijing launched a high-profile ‘anti-involution’ campaign aimed at reining in margin-crushing price wars across key industries in the second half of 2025. But some of the initiatives may further limit pricing power, instead of restoring it. For example, new rules for China’s internet platforms are intended to give platform merchants more pricing autonomy. But these regulations seem to be encouraging the platforms to step up pricing subsidies to try to defend their market share. The end-result is intense competition without profitability.
Taiwan’s Surge: The TSMC Effect
While China has been wrestling with involution, Taiwan has been benefiting from very different dynamics. Its equity market is being propelled by an idiosyncratic, AI driven growth engine centred on advanced semiconductors – and above all, by the mighty Taiwan Semiconductor Manufacturing Company (TSMSC). The firm is in the enviable position of commanding a near-monopoly in the cutting-edge chip technology that generative AI requires.
Taiwanese GDP growth is being turbocharged by global demand for that technology and its irreplaceable position in supply chains. In 2025, the country recorded its strongest GDP growth in 15 years. Investors are keenly aware that Taiwan sits right at the heart of the world’s AI build out. Its stock market has now overtaken the UK’s in value terms, with Taiwanese equities’ total market capitalisation hitting $4.13 trillion on 16 April, ahead of the UK’s $4.09tn.
US and Dutch controls on the export of certain semiconductor chips and manufacturing equipment to China have helped bolster Taiwan’s competitive advantages. So far, China’s push towards semiconductor self sufficiency has failed to close the gap with the world’s best high-end chip manufacturers. It’s still several years behind global industry leaders.
The end-result? Taiwan’s stock market has consistently delivered stronger returns with fewer governance risks, driving a steady upward re rating in index weightings. These factors support sustained earnings quality, pricing power and capital efficiency – all of which are rewarded under MSCI’s rule set.
Investment implications
This shift has important implications.
First, China is still a critical part of the EM opportunity set. But it’s no longer the monolithic growth engine it once was. As a high tech powerhouse challenged by structural weaknesses (including high levels of debt, aging demographics and deflationary pressures), investing in China demands selectivity, not blanket exposure. That presents big challenges to passive allocations which assume China automatically dominates EM risk and returns.
Secondly, we see big distinctions between ‘upstream’ China exposure and ‘downstream’ beneficiaries of China driven input cost deflation. We’re avoiding upstream Chinese industries where we believe margin destruction is structural – including EVs, solar and robotics. And instead, we’re focusing on the likely downstream beneficiaries across global EM. These companies benefit from China driven input cost deflation without being exposed to China’s pricing wars. We believe this approach will allow us to monetise China’s deflation without owning it.
Third, where we do look for recovery candidates within China, we apply a strict survivor framework. Historically, successful investments after periods of extreme overcapacity only emerge once the weaker players exit. Our selection criteria include deep share price drawdowns, a turn in free cash flow, clearly stable balance sheets and confirmation from market pricing. Until those signals appear, we won’t be catching any falling knives.
China dominates key parts of the robotics supply chain, including LiDAR (light detection and ranging) sensors, harmonic reducers, robot joints and industrial controllers – the ‘eyes, nerves and brains’ that enable robots to perceive and interact with the world. In our Rathbone SICAV Global Emerging Markets Equity fund, we’ve recently taken a targeted shot at a couple of potential survivors in the LiDAR sensor industry, making small allocations to both Shenzhen Inovance Technology and RoboSense.
*This percentage includes Hong Kong-listed Chinese stocks
