Baillie Gifford China Growth

RNS Announcement

Baillie Gifford China Growth Trust plc

Legal Entity Identifier: 213800KOK5G3XY17ZX18

Regulated Information Classification: Half Yearly Financial Report

Results for the six months to 31 July 2021

Over the six month period, the Company's net asset value per share (NAV) fell by 14.2% compared to a 14.8% fall in the comparative index, on a total return basis.

¾  The last 6 months has been a volatile period for Chinese growth equities.

¾  We saw a marked sell-off in US listed Chinese stocks, including Yatsen, KE Holdings and Bilibili.

¾  Positive contributors to performance included CATL, China's leading battery manufacturer, and Li Ning, a leading domestic sportswear manufacturer.

¾  Over the period, we have made a number of investments in companies exposed to China's green transition and to its industrial upgrading, including Longi Green Energy.

Past performance is not a guide to future performance

Total return information is sourced from Refinitiv, Baillie Gifford and relevant underlying index providers. See disclaimer at end of this announcement.

Baillie Gifford China Growth Trust aims to achieve capital growth over the long term from a diversified portfolio of 63 securities. At 31 July 2021 the Company had total assets of £265m.

Baillie Gifford China Growth Trust is managed by Baillie Gifford, an Edinburgh-based fund management group with approximately £335 billion under management and advice as at 12 October 2021.

Baillie Gifford China Growth Trust is a listed UK company. The value of its shares and any income from them can fall as well as rise and investors may not get back the amount invested.  The Company is listed on the London Stock Exchange and is not authorised or regulated by the Financial Conduct Authority.  You can find up-to-date performance information about Baillie China Growth Trust at bailliegiffordchinagrowthtrust.com‡. Past performance is not a guide to future performance

13 October 2021

For further information please contact:

Alex Blake, Baillie Gifford & Co  

Tel: 0131 275 2000

Mark Knight, Four Communications

Tel : 0203 697 4200 or 07803 758810

‡      Neither the contents of the Managers' website nor the contents of any website accessible from hyperlinks on the Managers' website (or any other website) is incorporated into, or forms part of, this announcement.

Interim Management Report

The last six months has been a volatile period for Chinese growth equities. There has been a raft of regulatory announcements that have weighed heavily on market sentiment resulting in valuation multiples contracting across a range of industries. Notable regulatory news includes the following:

 -   In the US, the Accelerating Holding Foreign Companies Accountable Act was signed by the Senate in June and may effectively reduce the window from 3 years to 2 years whereby Chinese companies who do not allow audit by Public Company Accounting Oversight Board accounting firms are forced to delist from US exchanges.

-    In China, the Data Security Law came into effect in June and requires Chinese companies to implement more stringent controls on data or to seek approval before exporting the data overseas if the data pertains to an area of national security.

-    The Chinese State Council has opened a period of consultation on Chinese variable interest entities (VIEs).

We believe the regulation above effectively encourages Chinese companies to list domestically, including in Hong Kong, rather than overseas. This has been a long-term aim of the Chinese government. As the Company is agnostic to the listing location of Chinese companies, we do not believe this regulation, taken at face value, is of particular concern. The Company itself has approximately 37% of NAV in VIE companies, including less than 10% of NAV in US ADRs.

More importantly, the Chinese government has again stipulated its desire to tackle the expansion of social and economic inequality, and to slow or even reverse the country's falling birth rate. Over the past two years we have seen increased regulation in the 'new mountains' of healthcare, education and property. This regulation has sought to reduce the principal costs associated with child rearing and the barriers to consumption growth. The State Council's 'Double Reduce Policy' in the education sector (where the Company has no exposure) is the most severe example of increased regulation. In response to inappropriate advertising by education companies, the government has effectively forced a wholesale restructuring of these businesses resulting in a significant cooling of sentiment towards China. This cooling of sentiment has also affected valuations of the big internet platforms. Here, the government continues to work through anti-monopoly probes at a number of these businesses whilst trying to tackle what it terms the 'disorderly expansion of capital'. The market has largely taken these regulatory moves as an attack on the private sector. We disagree and would note that the vast majority of regulation in the internet space has been remarkably sensible. Weeding out practices such as forced supply exclusivity and differential pricing is a positive for the companies we own. It encourages them to double down on what they do best i.e. building platforms that create significant value for all stakeholders.

As such, we remain happy to own companies such as Alibaba and Tencent at modest overweight positions. We continue to believe that, on balance, Alibaba's business is a strong force for good within Chinese society and therefore likely to continue growing over the next decade. Its ecommerce platform has created millions of jobs within China and continues to bring goods and services to the poorest of consumers. With ecommerce penetration below 30%, we think the growth opportunity and returns for shareholders remain sizeable, particularly given the current valuation. Tencent's social media platform, WeChat, remains the de-facto app via which almost all Chinese consumers organise their lives and via which Chinese corporates increasingly connect with their customers, suppliers and other stakeholders. Comparisons with Facebook do not do this business justice. Whilst the market obsesses over regulation which affects less than 10% of Tencent's business (namely restrictions on gaming time spent by under 18s), our attention lies elsewhere.

Outwith the internet space, the government continues to show support for sectors which will be key for China's next decade of growth, namely, advanced manufacturing, industrial upgrading and the renewables industry, all of which present sizeable opportunities for long term growth investors. It is here that we are increasingly focusing our investment research.

Portfolio Positioning and Recent Activity

The current portfolio represents a selection of the best and most innovative public and private Chinese growth companies. What you will see in the portfolio is a bias towards consumer discretionary and healthcare related businesses. However, over the period, we have made a number of investments in companies exposed to China's green transition and to its industrial upgrading. Longi Green Energy, a domestically listed A share company, is a good example of the former. It is a world leading solar module manufacturer, supplying roughly a quarter of the global market for solar wafers and modules. This is an industry in which demand for solar installation is expected to triple by 2025 and then triple again by 2030, as environmental benefits increasingly motivate governments around the world and economic competitiveness is driven by ongoing cost reduction. Longi have developed from a wafer manufacturer and are now building a growing downstream presence. Their cost base has been consistently lower than competitors, driven by a commitment to R&D, adoption of technology, scale and execution. We admire the founder's ambitions for our planet's future, his vision on smart energy solutions, emphasis on technology leadership, and a commitment to clients, employees as well as shareholders. This should position the company well to benefit from the many years of growth ahead of it. Shenzhen Megmeet, another domestically listed A share company, is a good example of the latter. Megmeet makes power supply and electric automation products for both industrial and consumer electronic clients. The company finds itself in the right place at the right time. It is exposed to exciting end markets that include industrial automation, new energy vehicles and advanced intelligent manufacturing. The management team have significant experience in the industry working at both Huawei and Emerson prior to founding Megmeet. The CEO and founder, Dr Tong, has instilled a company culture that is committed to R&D, innovation, and collaboration across departments. As the company grows, it is increasingly developing products into modules and modules into solutions to provide a one-stop service for clients and thereby deepening its moat. We expect continued growth to come from rising market share and expanding product lines. Organic growth will be complemented by bolt-on acquisitions, where management have the experience needed to deliver shareholder value. Megmeet has the potential to become a significant global player in industrial automation and to deliver substantial returns to investors.

In addition, the Company has also made an investment in one of China's leading semiconductor companies, SG Micro. China's desire for self-sufficiency in semiconductors has been strengthened by recent tensions with the US. As such, this is an industry which is likely to receive substantial policy support over the next two decades. SG Micro is a fabless integrated circuit (IC) designer of analog semiconductor chips. The company focuses on signal chain and power management solutions. Analog chips are increasingly applied in new fields including IoT, industrial control and the automotive sector, all of which have seen significant growth. 5G, smart home and smart city initiatives also bring new opportunities. The global analog chip market is very fragmented. China makes up 60% of global demand but is only 20% self-sufficient. SG Micro is China's number one domestic supplier, where revenues grew more than 100% in 2019. We expect a continued rise in demand, ongoing government support and new product application opportunities to drive significant growth in the years ahead. This is supported by a professional management team with global experience and a company culture that aligns with its long-term growth potential.

 In order to fund these new purchases, we have made a number of sales. As noted above, healthcare is one of the sectors in which regulation remains stringent. Here the government aims to incentivise innovation via pricing incentives for genuinely innovative drugs. The vast majority of the Company's healthcare holdings are likely to benefit from this trend. However, Jiangsu Hengrui does not appear as well placed given it still generates a substantial amount of revenue and profit from generic drugs, where pricing pressure is likely to increase. This, combined with the fact that we continue to find exciting opportunities in this space has resulted in us selling Hengrui's shares.

Other sales of note include Shanghai Airport and Foshan Haitian. Foshan Haitian is a leading soy sauce and seasoning company in China. Its growth is likely to be driven by consolidation in the soy sauce market and by diversification of its product lines.

 However, after a strong run in the company's shares and a significant re-rating, we have sold the holding on valuation grounds. Shanghai Airport is a good quality company with exposure to tourism and growth in the middle class. We have sold the company so that we can invest in higher growth ideas elsewhere.

Net gearing remains low at around 1%. This gives us the flexibility to invest in attractive opportunities as they become available without needing to sell shares from the rest of the portfolio.

Performance

Over the six months to the end of July 2021, the Company's net asset value fell by approximately14% on a total return basis and the share price fell by approximately 21%, reducing the share price premium to NAV. Over the same period, the benchmark fell by approximately 15%. We would hesitate to draw too much from short term numbers and would hope that shareholders judge our investment returns over periods of five years or longer, the same period over which we judge our companies' performance. In terms of the net asset value, notable positive contributors are varied. They include CATL, China's leading battery manufacturer and a key enabler of China's green transition; Li Ning, a leading domestic sportswear manufacturer; and Asymchem, a leading contract manufacturing company in the healthcare space. Relative performance was helped by the fact that we did not have any exposure to education companies that were negatively impacted by the regulator's 'Double Reduce Policy' as explained above. Save for KE Holdings, an online real estate business, the Company does not have any exposure to the property sector.

In terms of negative contributors, we saw a marked sell-off in US listed Chinese stocks. A number of our holdings were affected, including Yatsen, KE Holdings and Bilibili. Yatsen and Bilibili are exposed to two of the most exciting growth trends within China over the next decade: Generation Z and the rise of Chinese brands. As noted in previous reports, younger generations in China have radically different online behaviour and brand preferences to their older compatriots, along with strong and growing purchasing power. Yatsen is a potential leader in the cosmetics space in China with its strong domestic brand, and its innovative, data-driven approach to product development and customer interaction. If successful, this company could deliver exceptionally strong returns to shareholders. Bilibili, with its highly engaged, young user base, is both an enabler and driver of youth culture within China. The management team have prioritised building a strong and vibrant online community and are only just beginning to reap the benefits in terms of monetisation.

Meituan, an online marketplace for the local service industry in China, also featured in the top 10 negative contributors. Here, the government's focus on social inequality negatively affected sentiment. The regulator is pushing for greater protection of workers with a focus on expanding social security benefits and minimum wage requirements. We would note a couple of things. Minimum wage requirements are unlikely to have a substantial impact on Meituan's cost base given full-time delivery drivers earn substantially more than the minimum wage in most city tiers. The expansion of social security benefits to part-time drivers is likely to increase delivery costs. However, factoring this in, we believe that Meituan's business model remains more than viable and that long-term profitability will still be attractive. In addition, growth for this business continues to fire on all cylinders with revenues in the first quarter growing at approximately 130% year on year. We continue to believe that this is one of the best growth businesses in our universe and remain happy holders.

Outlook

Baillie Gifford has been investing in China for over two decades. As such, we have experienced numerous regulatory cycles, significant volatility and, at times, painful periods of adjustment. However, whilst investment in China may prove volatile over a short term time horizon, we continue to believe that a combination of a vast and growing domestic market, significant investment in research and development, and private and public equity markets that are poorly understood and very short term, give long-term growth investors like ourselves a real opportunity to generate returns for our shareholders.

The principal risks and uncertainties facing the Company are set out below.

Baillie Gifford & Co

For a definition of terms see Glossary of Terms and Alternative Performance Measures, see below.

Total return information is sourced from Refinitiv/Baillie Gifford and relevant underlying index providers. See disclaimer at the end of this announcement.

Past performance is not a guide to future performance.