From Baillie Gifford

Upheaval and opportunity in China’s reforming society

September 2022

Key Points

  • Chinese companies have been hit hard by a wave of government regulation, Covid setbacks and geopolitical tensions
  • Alarm over Beijing strangling the private sector is misguided – the aim is an olive-shaped society where innovative ‘little giants’ drive sustainable long-term growth
  • For those with patience and foresight to see the big picture of Chinese growth, this new phase of development has every chance of bringing rewards

Illustration by Jun Cen

Please remember that the value of an investment can fall and you may not get back the amount invested. This article originally featured in Baillie Gifford’s Autumn 2022 issue of Trust magazine.

Few in the west will have heard of Yunnan Energy New Material, a materials maker based in a remote Chinese province cradled by Myanmar, Laos and Vietnam. It is at the opposite end of China from Alibaba, the tech group synonymous globally with the nation’s stunning ascent – as well as its recent market turmoil.

According to Sophie Earnshaw and Roderick Snell, joint managers of Baillie Gifford China Growth Trust, "little giants" such as Yunnan Energy hold the key to why China’s long-term growth and investment prospects remain strong. To them, such rising companies on technology’s cutting edge represent big growth opportunities.

China has been enduring a wave of regulation, combined with Covid setbacks and geopolitical tensions. Its stocks have become so unloved that the MSCI China Index, which tracks most Chinese stocks, 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, to be misguided. The reality, they argue, is that the authorities see a revamped private sector as the engine of a new vision of ‘common prosperity’ for the next, more sustainable stage of Chinese development (see box below). With the world’s largest middle class – and global leadership in key fields such as 5G infrastructure and solar energy – they see the fundamentals in place for China to prosper on the back of a more controlled version of Chinese capitalism.


Going olive-shaped

In this vision of China’s future, dynamic innovators aligned with state-mandated social and environmental priorities will power an ‘olive-shaped’ society – an oval 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 therefore be set against the greater mission to create a successful, 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 current heavy hand can ultimately be expected to 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 hybrid model of state control and free competition, where Beijing calls the economic shots then gets out of the way. “The state sets priorities such as semiconductor self-sufficiency but doesn’t typically anoint the winner,” she says. “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, the firm has grown into the world’s 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 not only for domestic players such as electric vehicle battery maker CATL (another China Growth Trust holding) but also for global giants such as Panasonic and Samsung.

Common purpose

President Xi Jinping is staking China’s future on a vision of ‘common prosperity’, spelled out in a speech at the Central Financial and Economic Affairs Commission in August 2021. Xi called the new direction an “essential requirement of socialism and a key feature of Chinese-style modernisation”.

Some western commentators have portrayed this agenda as a rolling back of decades of market liberalisation. Others have interpreted it as the Communist Party of China’s bid to head off social unrest through more egalitarian development. They see it as a policy as much rooted in the Confucian concept of datong (‘the great unity’ – or utopia) as in Marxist-Leninist dogma.

As Xi told the World Economic Forum in Davos in January 2022: “The common prosperity we desire is not egalitarianism. To use an analogy, we will first make the pie bigger, and then divide it properly.”

Earnshaw and Snell say the sectors to favour in Chinese equities are those driving the common prosperity strategy. These include renewable energy, advanced manufacturing, semiconductors and healthcare. Some top picks from the Trust include:

    • LONGi Green Energy Technology: The world’s leading solar module manufacturer, LONGi supplies roughly a quarter of the global market for solar wafers and modules. It enables the green revolution through innovation, bringing down costs in wafer manufacturing and making solar power competitive with other energy sources.


    • SG Micro: The Beijing-based firm is a linchpin of China’s drive for semiconductor self-sufficiency, a crucial priority amid US-China sniping over technology. It specialises in applications central to China’s common prosperity mission, including mobility, wireless communication and advanced medicine.


    • BeiGene and Zai Lab: Healthcare is central to the common prosperity vision. Yet the segment has been weak recently under pressure to weed out non-performing players. Biotech firms such as BeiGene and Zai Lab 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 in the foreseeable future. China is “at the start of the regulatory cycle, not the end”, according to Snell. Critical to a successful China strategy is the ability to spot “the genuine innovators seen as doing the most social good” – alongside the patience to wait out inevitable storms.

“Having that long-term time horizon and being able to commit capital for a long period of time 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.”

At the time of publication, in addition to the Baillie Gifford China Growth Trust, the following trusts were invested in the companies mentioned above:

Alibaba - Monks, Pacific Horizon, Scottish Mortgage

LONGi Green Energy Technology - Pacific Horizon

Zai Lab - Edinburgh Worldwide Investment Trust

Important Information

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.

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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.

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