What to Know if Your Pension Plan Has to Divest from China

Eliminating exposure to Chinese stocks has complicated implications for public pension plans.

As the relationship between the United States and China evolves, some politicians and policymakers are expressing concerns about public pension plans' investments in Chinese stocks. In late 2024, treasurers from more than a dozen states cosigned a letter that strongly urged their states’ pensions to divest from China, including Hong Kong and Macau.

The prospect of divesting from China presents pension plans with a variety of challenges. The country has the second-largest economy in the world and makes up large portions of global equity indexes. As a result, any plan that eliminates China from its portfolio will meaningfully alter its balance of risk exposures, potentially undermining its diversification and growth potential.

Nevertheless, public plans may feel they have no choice but to divest. For those plans and others that want to eliminate China-domiciled companies from their equity portfolios, State Street offers a range of ex-China investment strategies.

The Challenges and Complications of Divesting From China

China is a massive player in the global economy. Its gross domestic product in 2023 was larger than the rest of the East Asia/Pacific region combined and almost four times as large as the next-largest economy, Germany.¹

The country’s weight in financial markets is similarly outsized. Mainland China makes up more than 30% of the market capitalization of emerging markets (EMs), based on the MSCI EM Index, and Hong Kong is included in many international developed-market benchmarks.

A plan divesting from China can take one of two approaches with its EM allocation:

• Eliminate China exposure and reduce its EM allocation commensurately. Say a plan’s strategic allocation prior to divesting called for holding 15% of the equity portfolio in EMs. The plan might invest in an EM ex-China strategy and reduce its EM allocation by 30% — China’s weight in the EM index — decreasing the total EM allocation to 10.5% of the equity portfolio. In effect, the plan would remove China while maintaining steady allocations to other individual EMs, and it likely would increase the allocation to developed-market equities by 4.5 percentage points.
• Keep the EM allocation steady but eliminate China. In this scenario, the hypothetical plan would shift from investing 15% of its equity portfolio in EMs including China to investing 15% in EM ex-China. This move would boost allocations to other individual EMs — particularly India, Taiwan, and South Korea, which together make up more than 64% of the EM ex-China index.

Sector exposures would change, too. For example, shifting from the broad EM benchmark to EM ex-China would reduce the EM allocation’s weight in consumer discretionary stocks by more than half, from 14.6% to 6.5% — decreasing exposure to potential growth related to the rise of EM consumers, among other changes. Meanwhile, the information technology weighting of the EM portfolio would rise by almost a third, from 22% to 28%, and would be dominated by a relatively small number of Taiwanese and Korean semiconductor firms, presenting greater concentration risk.

The information illustrated in figures 2 and 3 is based on companies’ country of domicile, as defined by MSCI. Rather than eliminating exposure to shares of companies domiciled in China and its territories, some plans may consider trying to eliminate exposure to shares of firms that generate revenues there. Although this move may be technically possible, it is likely to prove impractical and of questionable value. Data on revenue exposure is not reliably precise, so plans could not be sure they had truly divested from companies that derive revenues from China. And divesting from companies with Chinese revenues or that source Chinese parts in their supply chain would reduce plans’ investable universe to a very small subset of the global equity markets, exacerbating the difficulty of reaching return targets and managing risks.

Even removing exposure to companies domiciled in China and its territories would alter a portfolio’s risk-and-return profile meaningfully. As you can see in figure 4, the EM and EM ex-China indexes posted very different calendar-year performance over the five years through 2024. During that time, the ex-China index posted both higher volatility (standard deviation) and higher risk-adjusted return (Sharpe ratio). Moreover, the EM ex-China index had a significantly higher correlation to the US equity market than the broader EM benchmark did over the 10 years through March 2025.

Given the differences between the EM and EM ex-China indexes, plans divesting from China should expect increases in tracking error relative to their current benchmarks. For example, a plan that uses the MSCI ACWI IMI Index as its policy benchmark should expect to incur approximately 84 basis points of tracking error as a direct result of divestment from China and Hong Kong.² Divesting plans need to understand and consider this outcome. They may choose to change their policy benchmark to an ex-China index that is better aligned with their investable universe.

Another challenge: liquidating China holdings en masse may be expensive. Divesting plans are effectively forced sellers of potentially large positions in a market where trading can be inefficient. For large plans, these transactions could trigger trading costs that run into the millions of dollars. Where possible, plans should work with asset management partners to minimize transaction costs.

How State Street Can Help

State Street offers a variety of ex-China strategies, including ex-China EM strategies and ex-Hong Kong developed-market international and global strategies. (Avoiding shares of mainland- and Hong Kong-based firms effectively eliminates exposure to Macau as well.)

• MSCI Emerging Markets ex-China Index Strategy
• SPDR® S&P Emerging Markets ex-China Index Strategy
• MSCI ACWI IMI ex-China ex-Hong Kong Index Strategy
• MSCI EAFE ex-Hong Kong Index Strategy
• Emerging Markets ex-China Active Strategy
• Emerging Markets ex-China Enhanced Strategy
• Emerging Markets Small Cap ex-China Active Strategy
• Customized strategies

Our investment experts can help you understand the ways shifting to these strategies would affect your plan’s balance of risk exposures, and they can work with you to adjust the portfolio accordingly in light of its liabilities, restrictions, and objectives.

Our investment and trading experts also can help your plan minimize transition costs, capitalizing on our position as one of the largest participants in global financial markets. At State Street, we manage over $130 billion in EM equity assets. Our three global trading desks executed $41 billion in EM equity trades in 2024, with average commissions 11% lower than those at similar-sized peers. Our passive strategies routinely reduce client expenses through the use of a technique called crossing, in which we minimize transaction costs by matching selling clients with buying clients, whether they are trading individual securities or asset classes. In 2024, crossing reduced trading costs for our clients by an estimated 17 basis points, as less than a quarter of our EM equity order flow was traded on the open market.

Make the Most of a Difficult Situation

Public pension plans that have to divest from China find themselves between a rock and a hard place: They need to maximize the potential of their financial assets to meet liabilities and fiduciary responsibilities, even as their investment universe is constricted in ways that make it harder to do so. State Street’s strategies and experts are here to help you navigate this tricky terrain so your plan can achieve its mission.

Contact your relationship manager to learn more about State Street Global Advisors’ ex-China strategies.