Baillie Gifford China Growth (BGCG ) has written down the value of TikTok owner ByteDance, its only unlisted investment, in another tough half-year for the former Asia Pacific fund. 

The £154m former Witan Pacific, which Sophie Earnshaw and Roderick Snell took over in September 2020 after the board appointed Baillie Gifford, saw net asset value (NAV) fall 10.7% in the six months to 31 July, underperforming the 5.4% drop in the MSCI China All Shares index. 

Since the relaunch as a China Growth fund the portfolio has tumbled nearly 26%, though that is better than the 32.1% decline in the benchmark.

The shares have fared worse as their discount - or gap to NAV - has widened to 11%. This year shareholders have lost 32% and over three years are down nearly 22%.

One of the biggest detractors in the interim result was ByteDance, the platform company that owns social media video app TikTok, which Baillie Gifford’s valuation committee reduced by 15%.

‘We wrote down the valuation of ByteDance, the company’s only private holding, by 15% to reflect the contraction in multiples that we have seen in platform companies more broadly within China,’ they said.

China Merchants Bank, a listed consumer bank, also weighed as the share price slumped following news that the bank’s president had been removed under investigation.

However, Earnshaw (pictured below) and Snell said ‘the market tends to overstate keyman risk in the short term’.

‘The bank’s long-established management culture is unlikely to alter, and the impact on core operational performance should be limited,’ they said, pointing to strong recent results despite a challenging macro backdrop.

‘This is a bank with a strong consumer and wealth management platform and one that has a history of good and profitable lending. As such, we remain happy holders,’ they said.

The duo are also happy to hold Sunny Optical, a manufacturer of lenses and modules for smartphones and cars, despite it being embroiled in a price war in its core smartphone business with a new rival.

‘We think this increase in competition will not persist as the new entrant is loss making and unable to make an economic return. More positively, we think the growth potential in Sunny’s auto business, where it is one of the market leaders in lenses for autos, is vast,’ they said.

‘The primary driver here is the trend towards increasingly autonomous vehicles. We believe this growth potential is underappreciated and therefore remain happy to hold the stock.’

Chinese markets have come under pressure this year, mainly due to the ongoing and lengthy Covid-19 lockdowns that have persisted under its zero-tolerance policy and a weakening property market, fuelling concerns for Chinese growth as it is unlikely to achieve its previous GDP target of 5.5% for this year. 

The growth companies that the Baillie Gifford managers favour have also de-rated in the face of worldwide rises in inflation and interest rates that increase their cost of capital and threaten to erode future profits.

China can’t invade Taiwan

Geopolitical threats have also been a factor, as fears that a Russia-Ukraine style conflict could happen between China and Taiwan, have been rumbling in the background. Concerns came to a head when US speaker and Republican senator Nancy Pelosi visited Taiwan leading China to step up military drills in the region.

Despite concerns of military action and the ‘obvious displeasure’ of the Chinese government, the BGCG managers remained unconcerned about the stand-off.

They said there has been ‘no significant divergence from its longstanding policy’ on Taiwan, which is for a ‘peaceful reunification’. In a white paper, the Chinese government said military action would be a last resort. US president Biden has said the US would back Taiwan militarily if China invaded, raising the risk of conflict between the superpowers. 

They also noted that president Xi Jinping has given no deadline for when reunification needs to occur, and it is ‘loosely linked it to a date that’s 25 years away’ in 2049.

‘The work that we have commissioned from our third party research providers suggests that, even if China wanted to act militarily, it could not do so,’ they said.

‘It does not have the military capability. Indeed, Russia’s travails in Ukraine have thrown this into stark relief and the difficultly of an amphibious assault on Taiwan over 100 miles of water is a multiple of that of a land assault on Ukraine.’

New growth stocks

While Chinese stocks may have fallen out of favour this year, the pair said they continue to upgrade the growth profile of the trust and invest in companies ‘exposed to China’s next decade of growth’.

They purchased a new holding in Jiangsu Azure, which is a small battery maker selling into the power tools market.

‘The electrification of the power tools market is a strong structural driver for this company. Indeed, we believe its end market can double in five years as a result,’ they said.

‘In addition, Azure also has growth opportunities in similar markets such as vacuum cleaners and e-bikes.’

Kinlong, which sells hardware for doors and windows, was also added to the portfolio, and the managers said it was the number one player in a number of markets.

‘The growth opportunity is a function of continued growth in end markets, the expansion of its product portfolio, plus continued market share gains,’ they said.

‘Its products are a small proportion of total cost but are performance critical and therefore price sensitivity is relatively low.’

While the group has been hit by concerns over the property market, the managers said these were ‘overblown’.