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Baillie Gifford
Updated 02 Dec 2022
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This is a non-independent marketing communication commissioned by Baillie Gifford. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

The value of your investment and any income from it can go down as well as up and as a result your capital may be at risk.

Few in the west may have heard of Yunnan Energy New Material, a materials maker based in a remote Chinese province.

According to Sophie Earnshaw and Roderick Snell, joint managers of Baillie Gifford China Growth Trust, ‘little giants’ such as Yunnan Energy are key to China’s long-term growth and investment prospects.

China has endured regulation, Covid-19 setbacks and geopolitical tensions. Its stocks have become so unloved that the MSCI China Index, fell by 50 per cent between February and May 2022, making the entire Hang Seng Tech Index of the 30 largest tech companies listed in Hong Kong worth less than Amazon.

While acknowledging how hard regulation has hit some companies, the pair believe alarm over Beijing “strangling China’s private sector”, as Snell puts it, is misguided. The reality, they argue, is that the authorities see a revamped private sector as the engine of ‘common prosperity’. With the world’s largest middle class – and global leadership in 5G infrastructure and solar energy – they see the fundamentals in place for China to prosper in a more controlled version of Chinese capitalism.

Going olive-shaped

In this version, dynamic innovators aligned with state-mandated social and environmental priorities will power an ‘olive-shaped’ society – with a bulging middle class and shallow areas of extremes at either end. This will tackle gaping inequalities from the first phase of China’s economic miracle.

“China wants to avoid the middle-income-country trap of plateauing growth by driving sustainable prosperity,” says Snell. “It’s about avoiding getting left with a large underclass unable to contribute to the next couple of decades of consumer-led growth.”

The pressure on big tech, says Snell, must be set against the greater mission to create a developed society by mid-century in which wealth and power are not the preserve of a few dominant tech players.

“The anti-monopoly policies that are alarming people are actually good for the overall ecosystem,” says Snell. “They lead to better innovation and better consumer outcomes. Reducing the power of the big platforms such as Alibaba and Tencent is like removing large trees blocking light from the forest floor. It allows others to grow.”

Earnshaw adds that the state’s heavy hand may strengthen the tech giants: “It means they have to go back to what they did best – investing, innovating and making the platforms empowering.”

Picking winners in a reshaped society

Driving the common prosperity mission, says Earnshaw, is a model of state control and free competition, where “the state sets priorities such as semiconductor self-sufficiency but doesn’t typically anoint the winner … It lets the market decide. So in some ways, it’s the best of both worlds.”

Yunnan Energy embodies the model in action. Heeding a state call for excellence in electric vehicles, It has grown into the biggest manufacturer of lithium-ion battery separator film (the barrier between a battery’s cathode and anode electrodes that prevents short circuiting). It’s a critical niche that makes Yunnan Energy an indispensable partner for domestic players such as electric vehicle battery maker CATL (another China Growth Trust holding) and global giants such as Panasonic and Samsung.

Earnshaw and Snell say the sectors to favour in Chinese equities are those driving the common prosperity strategy. Some top picks from the Trust include:

  • LONGi Green Energy Technology: It supplies a quarter of the global market for solar wafers and modules, enabling the green revolution through innovation, cost reductions in wafer manufacturing and making solar power competitive.
  • SG Micro: A linchpin of China’s drive for semiconductor self-sufficiency – a crucial priority amid US-China sniping over technology. It specialises in applications including mobility, wireless communication and advanced medicine.
  • BeiGene and Zai Lab: These biotech firms stand out for their astute research and development investment, eyeing a global market while promoting wellbeing in China’s ageing society.

Stormy forecast

Earnshaw and Snell emphasise that volatility promises to be the ‘new normal’ of Chinese equities for the foreseeable. China is “at the start of the regulatory cycle, not the end”, according to Snell. Critical to a successful China strategy is spotting “the genuine innovators seen as doing the most social good” – alongside the patience to wait out storms.

“Having that long-term horizon and being able to commit capital for a long period is crucial,” says Earnshaw. “Share price swings of 30 or 40 per cent aren’t unheard of. This won’t be an asset class for everyone.

“For those with patience and foresight to see the big picture of Chinese growth, the new phase of Chinese development has every chance of bringing rewards.”

Sophie Earnshaw
Joint manager, Baillie Gifford China Growth Trust
Roderick Snell
Joint manager, Baillie Gifford China Growth Trust

Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates. The Trust invests in emerging markets, where difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment. The Trust’s exposure to a single market and currency could increase risk.

The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The article contains information and opinion on investments that does not constitute independent investment research, and is therefore not subject to the protections afforded to independent research.

Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions.

Baillie Gifford & Co Limited is wholly owned by Baillie Gifford & Co. Both companies are authorised and regulated by the Financial Conduct Authority and are based at: Calton Square, 1 Greenside Row, Edinburgh EH1 3AN.

The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the Financial Conduct Authority.

A Key Information Document is available by visiting bailliegifford.com

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