Baillie Gifford has been increasing its exposure to Chinese tech companies since the start of this year, despite the looming shadows of geopolitical tension and tariffs.
The Baillie Gifford China fund’s largest holding is internet company Tencent, followed by ecommerce platform Meituan and tech conglomerate Alibaba.
Tencent is deploying artificial intelligence in its advertising business, which has improved margins considerably in the past few quarters, said Linda Lin, head of the China equities team at Baillie Gifford.
Ecommerce giant PDD Holdings, which owns Temu (a cheaper version of Amazon), is also in the fund’s top 10 alongside electric vehicle company BYD.
China is developing its own semiconductor industry in a bid to become more self-sufficient. Currently, China imports half a trillion dollars of computer chips every year, which is more than its imports of oil and other materials combined, Lin said.
Baillie Gifford is investing in Chinese national champions such as Beijing-based semiconductor equipment company Naura Technology Group, which is researching lithography systems and has ambitions to move into the electric vehicle market.
The manager also recently invested in Horizon Robotics, which is a direct competitor to Nvidia in China’s autonomous driving chips industry.
Other investors are ignoring the dividend payments and share buybacks that Chinese tech companies are doing, Lin argued.
As part of the country’s recent economic stimulus package, Chinese banks can lend money to companies at low interest rates to encourage them to buy back shares. Chinese internet companies are paying decent dividend yields in the region of 3%, she noted.
Yet Lin is the first to admit that investing in China is risky. “In the past three years, China has been a very brutal market. I think it's driven by three very big pandas in the room.”
The first 'panda' is geopolitical risk, although the US-China tension and the situation in Taiwan are well understood and baked into share prices, she said. ByteDance is one of the fastest growing social media companies globally but is only trading on a price-to-earnings ratio of 5x.
China has offset the negativity from US tariffs by finding new markets for its exports. China is trading with south-east Asia, Latin America, Africa and the Middle East and is investing internationally through its ‘One Belt One Road’ global infrastructure development strategy.
Meanwhile, Baillie Gifford is monitoring the international revenue exposure of its Chinese holdings. In the China Growth Trust, only 6% of the portfolio’s revenue has direct exposure to the US.
Lin has stress-tested her portfolios against different levels of potential tariffs and expects a negative impact of about 85 basis points.
The second 'panda in the room' is domestic regulation covering internet companies, which became more intense in 2021. That period is now over, Lin stated: “The big technology companies in China are back to the centre of the growth stage.”
Alibaba chairman Joseph Tsai visited Baillie Gifford’s offices last year and said the Chinese government has finally realised how important private technology companies are for China's innovation over the next 10 years. Not only will internet companies be the driving forces of artificial intelligence and cloud computing in China but they will also function as training schools for software engineers and tech talent, Lin explained.
The third risk is China’s economy slowing – something the government stepped in to abate recently with a coordinated package of stimulus measures.
“China is not in a crisis but in a transition,” Lin argued. The drivers of China's GDP growth in the next five to 10 years will become industrial upgrading, the digitalisation of the economy and the green transition, she explained.
China does have an ageing population but it also has a growing middle class, which the government wants to double within five to 10 years. “We need to make sure China will not get old before getting rich,” she said.
China has about 300 million middle class citizens (defined as having an annual income of $35,000) but the government’s blue sky scenario involves swelling the ranks of its middle class to 800 million. A single country having a middle class that large is “something we haven't seen in human history”, Lin said. This matters because consumption is still one of the most important drivers of China’s economic growth.
Against the three risks outlined above, Lin is weighing China’s growth opportunities. The country houses more than 40% of the world’s growth companies, defined by revenue growth above 15% in the next three years, she said. Meanwhile, valuations are at a 20-year low.