The value of any investment can fall as well as rise and investors may not get back the amount invested.
China has long held great opportunities for investors but also presented a need to navigate its higher risks and volatility as an emerging market – and its different political culture.
Heightened geopolitical tension has dampened relations between China and the West. Chinese authorities are also dealing with a stuttering economy and ongoing problems from the Covid-19 pandemic, so many investors may decide the time isn’t right to invest.
But shunning China means passing up on the combined promise of its disruptive growth companies and business and consumer market, says Baillie Gifford China Growth Trust joint-manager Sophie Earnshaw.
She argues that investing in a selection of the best Chinese growth companies, with fund managers who know them in detail, presents a way to profit from the country’s advanced technology and its rapidly developing consumer economy.
Baillie Gifford China Growth Trust joint manager Sophie Earnshaw looks for 40 to 80 of the country’s best growth companies to invest in
‘China is the most important country to get right in people’s portfolios in the next few decades’, says Earnshaw.
‘It offers unparalleled opportunities to growth investors, not just in an emerging markets context but in a global context.
‘If you’re not investing in growth companies in China, you’re missing the point. It is one the most exciting opportunities for growth investors.’
Baillie Gifford China Growth Trust invests in 40 to 80 companies that Earnshaw and joint manager Roderick Snell see as having the ability to develop.
She says: ‘We mean those companies that can at least double the size of their business and share price on a five-year view.
‘Our investment philosophy, long-term growth and active investing are ideally suited to the Chinese market. One of the main reasons is that China in aggregate is a very short-term market, where trading volumes are 80 per cent dominated by retail investors who typically only hold stocks for months rather than years.
‘Our long-term philosophy is a real differentiator there.’
But in a market where pitfalls abound, the managers do not just look for the promise of high growth, they also pay keen attention to the robustness of balance sheets and corporate governance.
Earnshaw says that while the opportunity for growth is great, people should view China as a higher risk part of their broader investment portfolio.
‘This is a volatile market with drawdowns of 20 per cent, 30 per cent or even 40 per cent not uncommon over shorter time periods. As such, it is also important to make sure one can invest with at least a 5 year, and ideally a 10 year, time commitment.’
She believes it is also important to consider the role of the Chinese state and to go with a fund or trust that has an active investing philosophy – and doesn’t simply follow the index.
Spreading risk across a selection of different companies in different industries is important for the trust for managing potential volatility, but Earnshaw says China is a stock market where trying to diversify simply by following the index doesn’t work.
‘There’s a huge amount of the index that you’d want to avoid’, she says. ‘That’s why a relatively concentrated portfolio is the way to go.
‘The index still has a lot of exposure to no-growth industries, for example, the utility space, increasingly the property sector, and a huge chunk of the banking sector.
‘A lot of the index is dominated by state-owned enterprises and these types of companies are typically not managed in the interests of minority shareholders.’
|4. Kweichow Moutai||4.2|
|5. China Merchants Bank||3.9|
|6. Ping An Insurance||3.9|
|8. Li Ning||3.0|
|Source: Baillie Gifford & Co. As at 31 March 2022|
Earnshaw says that there is ‘a huge array of exciting growth opportunities in China’ and flags its rapidly improving renewables, technology, and engineering sectors.
Among the companies in the investment trust’s top 10 holdings are some names that will be familiar to many UK-based investors.
Tencent, Alibaba and ByteDance are global leaders in the digital world. Tencent and Alibaba have taken social messaging, gaming and marketplace and turned them into an integral part of China’s digital economy, from online payments to cloud computing. Most investors will also be familiar with ByteDance’s viral video social media platform, TikTok.
This trio of big names is an example of how China’s economy has shifted, with the state pushing for it to become a global cutting-edge tech and manufacturing player, rather than the mass-producer of cheap items that it was once characterised as.
The Communist Party, under leader Xi Jinping, is driving some growth areas that it wants China to be a world leader in and companies can benefit from the tailwind of state support and an immense consumer and business market.
On renewables, Earnshaw says: ‘This is a sector where China increasingly leads the world. It’s no longer a follower in renewables. It has some of the world’s largest and most technologically proficient companies.’
She cites CATL, which has become one of the world’s largest electric vehicle battery manufacturing companies and says that China is investing huge sums in EV infrastructure and decarbonising its economy.
ByteDance, the parent of social media app TikTok, is among Baillie Gifford China Growth Trust’s top ten holdings
Yet, the all-powerful Chinese state can also bring headaches for investors. China is a control economy and society, and the Government can use strong tactics that would not be considered acceptable in much of the West.
The Chinese state tries to influence the direction of companies and a move against those it sees as stepping out of line can prove highly damaging to their share price and investors.
Earnshaw says that means that as investors they must assess companies in a different light to how managers may look at US, European or UK firms.
She adds: ‘At Baillie Gifford, we’ve been investing in China for almost three decades now and one of the things we’ve learnt is that you cannot ignore the broader political landscape. You need to factor in these sorts of considerations when you look at the growth opportunities for a company and when you value it.
‘We try to do that in a number of ways. The questions we ask for all Chinese companies we invest in are does this company contribute or benefit from China’s economic, societal or environmental development and what is the global context?
‘It gets us thinking about alignment with the Government’s broad policy objectives on a long-term horizon.
‘These are things you have to consider when you invest in China, it does make the asset riskier in the sense of volatility than other asset classes but if you have the resources and the framework and the knowledge about China, these are risks that can be mitigated and in the long run should allow you to generate alpha and good returns.’
On the flip side, the heft of the state can provide a real tailwind for companies to succeed, especially those that are positioned well to profit from China’s development.
Advanced manufacturing is a main part of China’s strategy and has seen a shift into semiconductor chip-making, with firms building their position among the world’s big chip design as well as making a push in automation and robotics to challenge Japan’s leading firms.
Earnshaw says: ‘One of China’s policy priorities is to move up the value chain and to reduce its import dependency for high tech components such as chips. It wants to be at the cutting edge. We’re starting to see this in the semiconductor space with a company like SG Micro.’
The managers also take a keen interest in the advanced healthcare sector, with stocks such as biotech firm Burning Rock. Meanwhile, among the next generation of growth companies that the trust sees as emerging with the greatest promise are those that can profit from the changing face of China’s consumer economy.
The size of China’s consumer economy means that some of these companies, such as food delivery firm Meituan, can benefit from potential domestic markets and economies of scale that disruptive western firms could only dream of.
Investors to this part of the global growth story who back future winners could reap handsome profits, but the message from Baillie Gifford China Growth Trust is that they must pick stocks carefully and accept volatility along the way.
The Baillie Gifford China Growth Trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment to go down or up. The Trust’s exposure to a single market and currency may increase risk. The Trust invests in China, often through contractual structures that are complex and could be open to challenge, where potential issues with market volatility, political and economic instability including the risk of market shutdown, trading, liquidity, settlement, corporate governance, regulation, legislation and taxation could arise, resulting in a negative impact on the value of your investment.
This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.
Baillie Gifford & Co and Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investments trusts managed by Baillie Gifford & Co Limited are listed UK companies and are not authorised and regulated by the Financial Conduct Authority.
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