An ‘extraordinary’ and ‘painful’ third year of stock market falls in China has surely left former Witan Pacific shareholders regretting the trust’s relaunch as Baillie Gifford China Growth (BGCG ) in September 2020 when they approved the dropping of its regional approach and switched to a single country mandate under the Edinburgh-based managers.

Annual results last week showed the investment trust suffered a 40.9% slump in net asset value (NAV) in the year to 31 January, 10.4% worse than the 30.5% slide in the MSCI China All-Share index.

This was the third successive underperformance of the benchmark, following a 5.7% drop in the previous 12 months when the index slipped 2.2%, and before that in the 12 months to January 2022 (Baillie Gifford’s first full year in charge) when NAV tumbled 27% against a 20.5% slide in the MSCI China.  

What this means is that since Baillie Gifford took over, the shares have halved, although that is no worse than rival JPMorgan China Growth & Income (JCGI ), but may leave Fidelity China Special Situations (FCSS ) investors feeling a bit better about their 35% decline over the same period.

With all three trusts trading at about 10% below NAV, the sector and country are clearly out of favour, but that probably intensifies the sense that it was a mistake to ditch Witan Pacific’s Asia including Japan approach.

Over the past three years, while shares in the three China trusts have plunged by 52% on average, large company Asia Pacific trusts have fallen an average of 15%. That’s not a strictly accurate comparison as most regional Asia funds do not invest in Japan in the way that the Witan trust did. Nevertheless, the point is made. A single country, even as large as China, brings concentration risks.   

Peak to trough loss of 69% 

One feels sorriest for investors who piled in after Baillie Gifford’s appointment. The shares rallied to a peak of 634p in February 2021, at a premium of around 20% above NAV, when Beijing began its regulatory drive against internet companies. From that lofty vantage point to 196p today, the loss has been 69%.

Anyone who has suffered those losses may want to give Sophie Earnshaw and new co-manager Linda Lin a grilling at the annual general meeting in London in June. Besides that, they may feel that they have no choice but to hang on and hope that the managers are right that Chinese equities are extremely cheap as a result of bearish geopolitical sentiment and will bounce back when the top-down pressures recede and international investors stop pulling out of the country.

Earnshaw and Roddy Snell, who has recently stepped off the trust to focus on Pacific Horizon (PHI ) and his other Asian funds, said MSCI China stocks traded on about nine times forecast earnings for this year. That is below their five- and 10-year averages and less than half the 20 times multiple on the US stock market and much lower than the 16.6 multiple on global equities.

Growth not rewarded

The portfolio of growth stocks is more highly valued than the Chinese market, but at 12 times earnings has also derated, despite the managers’ stocks delivering annual earnings growth of over 10%.  

An underweight to energy stocks – the only sector to post a positive return over the year in the last financial year – and its avoidance of state-owned businesses in favour of private ones, weighed on the fund, they said.

Domestic sportswear brand Li-Ning was the main detractor over the year as it faced increasing competition from the likes of Adidas as well as dealing with a weakening consumer backdrop.

‘After the correction and the additional research we conducted, we are minded to continue holding the shares,’ the managers said.

‘We believe the brand remains relatively strong and that this is not reflected in the 10 times price/earnings multiple we are now being asked to pay.’

Construction software provider Glodon and analogue chip designer SG Micro both suffered in the year and are examples of times when ‘cyclical issues have overwhelmed the structural case in the short term’.

SG Micro will benefit from China’s desire to reduce its import bill and build a homegrown semiconductor industry, while Glodon helps the construction industry to reduce costs and increase efficiency in an area where software penetration is low but rising.

E-commerce giant Meituan, the fifth-largest holding, also saw a ‘marked’ share price fall despite delivering 25% revenue growth in the first nine months of the year and turning profitable.

‘Extraordinary divergence’

The managers said they were ‘cautiously optimistic’ about China’s continued shift away from the ‘old model of property-led growth to a new model of innovation-led growth’, and the growth opportunities are ‘reflected in the operational performance of the companies we own’.

‘Our listed holdings delivered 17.7% underlying earnings growth,’ they said. ‘Despite this, the portfolio’s value fell 40%. This extraordinary divergence between earnings and value is a reflection of sentiment, rather than operational performance.’

While the past few years have been difficult, China is still ‘an exciting hunting ground for growth investors’, they concluded. They pointed out that of all the companies in the MSCI All Country World index forecast to grow revenues by 20% a year for the next three years, 40% of them came from China. Their investors will hope the market finally comes around to seeing their achievements in a more positive light.