Baillie Gifford China Growth Trust — Year of a bull in motion

BG believes that the recent actions taken by Chinese financial regulators over the past few months imply that anti-monopoly regulations apply to all enterprises, big and small. BGCG’s fund manager, Sophie Earnshaw explains that formal and distinct regulations, stopping anti-competitive behaviour, give comfort to international investors. Following rapid exponential growth in e-commerce enterprises such as Alibaba and Tencent in a very benign, relatively unregulated environment, BG welcomes actions by regulators to create a universal corporate regulatory framework.

With recent actions including a $2.8bn fine on Alibaba (top 10 holding at 9.1% of the portfolio at 31 March 2021, see Exhibit 2), regulators acted to stop the company opening shops on other smaller platforms and ‘squeezing’ competitors out. The regulators focused on one of the major anti-competitive practices – merchant exclusivity where a company/seller would have been required to only sell its goods and services on Alibaba’s merchant platform (they would have had to choose between doing business with Alibaba or its rivals). BG considers the $2.8bn fine as a positive outcome, and an amount that Alibaba can easily afford. It accounts for around 4% of Alibaba’s domestic revenues. The platform remains intact and operational after this fine, with a long-term growth opportunity in e-commerce and its cloud segment.

The financial press interpreted these events as a steep change in the government’s actions. BG does not view it in this way. The government is trying to regulate big businesses in China in the same way that the US and now Europe are trying to regulate big tech. The Chinese government is very reliant on private companies for innovation. As it depends to a large extent on these businesses, the government is unlikely to break them up completely, according to BG.

The publication of draft anti-monopoly regulations by the Chinese financial regulator at the end of 2020 and suspension of the expected high-profile $34bn Ant Group’s IPO in November last year sent Chinese equities markets into a downward trend over the past few months. Lingering international investor concerns over potential tightening rules on the nation’s technology sector and an ongoing dispute with the US have resulted in the MSCI China Index returning 2%, compared to the MSCI World rising by 21%, over the past six months, on a TR basis in GBP.

Exhibit 1 shows the Chinese equity market selling off materially from its highs in February 2021.

Regulatory scrutiny of Chinese corporations coupled with uncertainty over US/China relations, have kept the performance of Chinese equities subdued year to date. While China was the first country to emerge from the pandemic about nine months ago, global newsflow continues to be dominated by COVID-19, contributing to investors’ cautious stance about the Chinese market.

Alibaba has ample room not only to further expand its Chinese e-commerce division, which is still growing at double-digit rates, but also its cloud business, which is currently c 8% of total revenues. According to Earnshaw, Alibaba’s market-leading cloud segment, which has a 45% market share in China, could be 5–10 times larger in five to 10 years and currently presents a very large growth opportunity. Scale matters for cloud infrastructure businesses, as it can create cost and pricing advantages for the market leader. BGCG’s team has frequent conversations with Alibaba – while the company’s management is keen to comply with regulations, it is excited about growth opportunities. According to BG, Alibaba still intends to float Ant, but has not yet specified what Ant’s business will be, following recent regulatory changes.

The country is opening its financial markets to attract more investments as it seeks to expand its economic base. According to Fang Xinghai, vice chairman of the China Securities Regulatory Commission, China plans to increase inclusion of A-shares’ in quoted companies that are traded in mainland China, in major global indices, and continues to expand the scope of inclusion to attract more foreign investment. April’s Boao Forum, which is known as ‘the world economic forum of Asia’, was attended by a number of global representatives, such as the heads of the International Monetary Fund and United Nations and western business leaders, including Apple’s Tim Cook, Tesla’s Elon Musk, Blackstone Group’s Stephen Schwarzman and Bridgewater Associates’ Ray Dalio. Fang said on the forum that foreign institutional investors such as mutual funds, pension funds and insurance funds are ‘very welcome’ in China. He added that as of the end of March 2021, foreign capital held 5% of China’s stock markets.

The A-share market is c 80% retail dominated. According to BG, the government intends to stabilise the market make it more standardised and internationalise the RMB over the longer term. As an illustration of its progress, China has put a lot of effort into opening the bond market. A recent example in April was the successful $3bn convertible bond placing by one of BGCG’s top 10 holdings, Meituan Dianping (4%), which was run by two Western banks. The investment manager sees a similar development and international maturation pattern in the equity market.

Meituan Dianping, an online marketplace for the local service industry in China, operates in more than 200 categories in 2,800 cities. It has a strong market share in on-demand restaurant delivery, in-store dining, hotel booking and film ticketing. Over the long term, the managers view these segments, all in the early stages of development, leading to strong growth expectations for many years to come. This is despite short-term volatility in the company’s share price. Recent newsflow around the company has been mixed and resulted in the share price falling by over 30% from its February peak to end-April. In April, the company raised c $7bn equity and c $3bn debt. Meituan intends to use the proceeds from the stock and bond sales for technology innovation, including research and development of autonomous delivery vehicles, drone delivery, other cutting-edge technology and general corporate purposes. Shortly after the capital raise the State Administration for Market Regulation announced an anti-trust investigation into Meituan’s activity. The company said that it would actively cooperate with the investigation and make efforts to comply with the regulations, and that it is currently operating as usual. BG considers the State Administration’s actions as a step in creating a more formal and universal corporate regulation system in China.

The managers bought their first holding in private company ByteDance, a social media and short form video company (top 10, 4.3%) in December 2020. BG has been invested in the company since May 2019. The managers believe that ByteDance is currently at a fairly early stage of monetisation of user activity and has a very large growth opportunity in advertising in addition to more nascent areas.

Little surprised by short-term volatility, the BG team is optimistic about the prospects for long-term investments in China. It expects China to be one of the key markets in the coming decade. The team sees the fundamental backdrop as favourable for Chinese equities due to robust earnings growth and global portfolios gradually increasing their exposure to China. The IMF’s January 2021 expectation is for the Chinese economy to grow 8.1% in 2021 and 5.6% in 2022. Together with growing consumption from the Chinese middle class, this increase should provide support for corporate earnings and equity markets.

Following the reorganisation in September 2020, BGCG returned 9.2% over the six months to end-April, outperforming the MSCI China All Shares Index, on the NAV total return basis. The trust underperformed the MSCI World Index over six months and shorter periods, as shown in Exhibit 3, as its exposure to a number of large Chinese companies, which fell more than the global index, affected performance. BGCG outperformed the BG China open-ended fund over the three short periods since its takeover by BG.

While BGCG was launched recently, the superior performance of BG’s Chinese strategy is illustrated in Exhibit 4 by the performance of the BG China OEIC, launched in November 2008. It continues to outperform the closed-ended Asia Pacific sector average over 3,5 and 10 years.

Positive contributors to BGCG’s performance during the period included healthcare holdings such as Zai Labs, an innovative biotech company, WuXi AppTec, a leading contract research organisation, and Kingmed, a diagnostics company. Other positive contributors include CATL, China's leading electric vehicle battery maker, and Estun, a prospective future leader in robotics and factory automation. Notable detractors over the period include Brilliance China, BMW's partner in the Chinese auto market, and Berry Genomics, a gene sequencing company.

The new investment policy aims to produce long-term capital growth only. Given this, investors should not expect to receive the same level of (or any) income after FY22 as they did before the trust was restructured. To mitigate the transition of the strategy to growth from ‘growth and income’, the board agreed the 7.15p per share dividend in respect of FY21 (to 31 January 2021), in line with the FY20 level, and intends to pay the same dividend in FY22. The dividends will be paid in October and June, respectively, from the company’s £11.6m (at 31 January 2021) revenue reserves.

BGCG currently trades on a 5.8% cum-fair premium to NAV. We believe that this is a healthy premium level and in line with that of many other BG investment trusts. The premium, shown in Exhibit 5, was very volatile in the first few months following the company’s restructuring. Due to high investor demand, the initial 10% of the additional share capital authority, approved by the board and shareholders in June 2020, was allocated quickly after the BG’s appointment, and the premium spiked. The next 20% of capital authorisation was approved in November 2020 and exhausted by end-March 2021, when the company authorised another 20%. Since then, the company has issued c 300K shares and continues to issue them.