All investment strategies have the potential for profit and loss, capital is at risk.
The moment I left the airport and traveled along the busy highway into Shanghai something struck me as different. I had become accustomed to seeing more electric vehicles in cities across the world, but here I found myself surrounded by them.
In Shanghai, this is far from unusual. Half of all new cars sold in the city are electric. Across China, a total of 6.8 million electric vehicles (EVs) were sold last year alone. That’s over 60 per cent of the total sold globally and dwarfs the less than a million sold in the US. When meeting with BYD, a leading EV maker, they told me they expect 90 per cent of new car sales in China to be electric within five years. China is therefore on a clear path to being the first major economy to make the EV transition.
Crucially this is a homegrown transition. While the Chinese automotive market has long been dominated by foreign brands, in EVs it is local brands that dominate, with a commanding market share of over 80 per cent. China is already the world’s leading EV manufacturer and is likely to become the global automotive leader. In the words of Ford’s CEO Jim Farley, “It’s a bit of a new world order”.
None of this has happened overnight. It is the result of industrial policies dating back to the turn of the millennium. China understood that with cars, that use internal combustion engines, it would always be playing catch-up with the Germans, Americans and Japanese who had been perfecting the technology for decades. EVs offered a reset, a level playing field and an opportunity to leapfrog. The government supported the industry’s development with large procurement contracts to build electric buses allowing EV and battery manufacturers to build scale and accumulate experience. It then poured in over $30bn of subsidies to nurture the electric passenger car market while giving preferential access to highly sought-after new urban license plates.
The advantages that China has built up will be hard to overcome. It dominates the EV supply chain with three-quarters of the world’s battery manufacturing capacity and is home to the world’s two largest battery manufacturers, CATL and BYD. CATL’s co-founder Li Ping said over dinner that it now has a research and development budget double the rest of the battery industry put together. China also controls the supply chain for battery components and is home to half the world’s processing and refining of essential raw materials for electric vehicles such as lithium, cobalt and graphite.
The combination of economies of scale, supply chain domination, accumulated battery experience, and lower labour costs now confer a significant cost advantage on China’s EV makers. William Li the founder of our holding NIO, a premium Chinese electric car company, believes this cost advantage is about 20 per cent. For this reason, Tesla now produces over half of its cars from its Shanghai factory. The west will need companies like European battery manufacturer Northvolt to succeed to avoid total dependence on this supply chain.
Yet it is not just cost where China is showing leadership. Innovation is plentiful. NIO has built out a battery swapping network allowing customers to swap for a fully charged or longer-range battery depending on need. The car drives itself into the swap station and without human intervention the battery is taken out of the car and replaced in a matter of minutes. NIO also has a popular AI-powered in-car assistant that can provide directions, play music, change the temperature, take that much-needed in-car selfie, or tell you off when you are not paying enough attention to the road.
The aim of many of the Chinese EV companies is now to go overseas. NIO is expanding further into Europe. It even has a new brand called Firefly designed specifically for the European consumer. If Chinese automotive domination of Europe sounds farfetched then consider that the second best-selling electric car in the UK is the MG4 made by Chinese state-owned enterprise, SAIC. Top Gear and other automotive media have greeted it with rave reviews. The real challenge for Tesla therefore seems highly unlikely to be Ford, Toyota, or Volkswagen but Chinese electric vehicle makers. However, electric cars were not the only radical change at nearly unimaginable scale I encountered during two weeks in China. I could have talked about how China is expected to build out 150GW of solar capacity this year. That’s greater than the entire installed capacity of the US. Alternatively, I could have talked about my surprise that another holding, food delivery company Meituan, did over 100,000 drone deliveries in Shenzhen alone last year. The joy of ordering everything from breakfast to dinner to a refreshing iced tea delivered across the urban sky was made to seem almost mundane.
Despite this awe-inspiring progress, it would be wrong to deny that investing in China has become much harder. The geopolitical risks are genuine and complex. Our assumption is that Sino-US relations are characterised by chronic tensions. There is at least good reason to try to keep these tensions in check. For the US and China, the cost of not doing so is not mutually assured destruction but rather mutually assured stagflation – slow growth, high unemployment, rising prices – should there be a true decoupling and fracturing of global supply chains. The Taiwan Strait is the obvious flashpoint but it would require a significant change in the military capabilities of the US or China for either side to believe anything but the most pyrrhic of military victories would be possible. Accidents and miscalculations are the real risk, at least for now.
China’s regulatory environment also presents its own challenges. We need to be open that we have not navigated these as well as we should have. The pandemic limited access and we relied on too narrow a set of corporate leaders for insight. This trip, our first since the pandemic, allowed us to meet a wide range of knowledgeable contacts.
The message received was one of optimism albeit from a low base. A leading economist noted that the government knows it made mistakes in its handling of the regulatory clampdown, but we should not expect it to admit that. Multiple founders noted “a massive sea change” with the appointment of the new premier, Li Qiang. In China, the premier traditionally manages the economy but his predecessor Li Keqiang was a former rival of President Xi. This made coordinating policy difficult as Li Keqiang was seen by regulators as speaking without the authority of the president. Now, we were told by multiple founders, Li Qiang, a Xi protégé, can push through a pro-growth, pro-business agenda with greater ease.
Shortly after my visit Li Qiang referred to consumer internet companies as the “trailblazers of the era,” while the government signalled the end of a period of ‘rectification’ for financial technology companies. There will still be regulatory issues in the future but all those we met seemed to agree that the situation was now much improved.
What remains clear though is that the geopolitical and regulatory risks need to be factored into our analysis and valuations of companies. The result has been that we have further raised our bar for investing in China. Investments in China must offer the possibility of truly exceptional upside to compensate investors for the risks incurred. This reassessment has driven reductions in our investments in China over the last couple of years. As part of this we sold our longstanding holding in Alibaba. We do not think the shares are particularly expensive but nor do we believe it offers the potential of truly exceptional upside to meet this higher bar.
However, given that China is a continent-sized country, with bold industrial policies and an ambitious entrepreneurial culture, the possibility for extraordinary firms to emerge still seems high. Last year was a good reminder of this as, despite the negative China headlines, Pinduoduo, another Chinese holding, has continued to grow both top and bottom line very rapidly despite an undemanding valuation. Many in the West are also now getting to know Pinduoduo through its international version Temu which has been dominating app downloads around the world.
The future will always be uncertain but what I am convinced by is that any attempt to understand the world without trying to understand China is doomed to failure. There is still much we need to observe and learn from the world’s second-largest economy and its ambitious and innovative companies.
Risk factors
The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in October 2023 and has not been updated subsequently. It represents views held at the time and may not reflect current thinking.
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this communication are for illustrative purposes only.
Important information
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Financial intermediaries
This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.
Europe
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018. Baillie Gifford Investment Management (Europe) Limited is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. Baillie Gifford Investment Management (Europe) Limited is also authorised in accordance with Regulation 7 of the AIFM Regulations, to provide management of portfolios of investments, including Individual Portfolio Management (‘IPM’) and Non-Core Services. Baillie Gifford Investment Management (Europe) Limited has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. Through passporting it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (‘FinIA’). The representative office is authorised by the Swiss Financial Market Supervisory Authority (FINMA). The representative office does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.
China
Baillie Gifford Investment Management (Shanghai) Limited 柏基投资管理(上海)有限公司(‘BGIMS’) is wholly owned by Baillie Gifford Overseas Limited and may provide investment research to the Baillie Gifford Group pursuant to applicable laws. BGIMS is incorporated in Shanghai in the People’s Republic of China (‘PRC’) as a wholly foreign-owned limited liability company with a unified social credit code of 91310000MA1FL6KQ30. BGIMS is a registered Private Fund Manager with the Asset Management Association of China (‘AMAC’) and manages private security investment fund in the PRC, with a registration code of P1071226. Baillie Gifford Overseas Investment Fund Management (Shanghai) Limited 柏基海外投资基金管理(上海)有限公司 (‘BGQS’) is a wholly owned subsidiary of BGIMS incorporated in Shanghai as a limited liability company with its unified social credit code of 91310000MA1FL7JFXQ. BGQS is a registered Private Fund Manager with AMAC with a registration code of P1071708. BGQS has been approved by Shanghai Municipal Financial Regulatory Bureau for the Qualified Domestic Limited Partners (QDLP) Pilot Program, under which it may raise funds from PRC investors for making overseas investments.
Hong Kong
Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Suites 2713–2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.
South Korea
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Japan
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Australia
Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence No 528911. This material is provided to you on the basis that you are a ‘wholesale client’ within the meaning of section 761G of the Corporations Act 2001 (Cth) (‘Corporations Act’). Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client. In no circumstances may this material be made available to a ’retail client’ within the meaning of section 761G of the Corporations Act.
This material contains general information only. It does not take into account any person’s objectives, financial situation or needs.
South Africa
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
North America
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.
The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.
Israel
Baillie Gifford Overseas Limited is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755–1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.
10040835 77038
