China is a technology powerhouse: how can you gain exposure?

The latest battery pack from Chinese company CATL promises to put range anxiety to bed for good, with the potential for 1,500km on a single charge. When they finally come to top up, electric car drivers can add 520km of range in just five minutes. Chinese car maker BYD has introduced a vehicle-mounted drone platform. In theory, the average Chinese electric car driver could drive from Beijing to Shanghai on a single charge, receiving food deliveries on the way.

This is just one way Chinese manufacturers are reshaping industries and a clear sign of China’s extraordinary innovation impulse. China is leading the way on patents, currently submitting around 4x the level of patents as the US. It is a global leader in areas such as robotics, clean energy technology and electric vehicles (EVs), and is increasingly competitive with the US on artificial intelligence (AI).

Yet many conventional economic indicators for China look depressing. Retail sales, for example, have barely grown over the last 12 months. The housing market, long a drag on household wealth, continues to go backwards. Deflation is a spectre looming over the economy. There is huge over-supply in certain industries thanks to inefficient government subsidies and difficulties in key export markets, such as the US.

Potential investors in China must deal with these competing realities. The Chinese stock market has real breadth and encompasses the good and bad of its economy. On the one hand are innovation powerhouses, on the other are sclerotic state-owned enterprises run for the good of the country rather than the good of shareholders.

Shifting sources of growth

For Will Mackintosh-Whyte, fund manager of asset manager Rathbones’ multi-asset portfolios, this is the sign of an economy in transition.

“We believe that the growth model in China is changing,” he says. “Property and infrastructure are no longer doing the heavy lifting they once did. Increasingly advanced manufacturing – semiconductors, automation, robotics, machine tools, EVs, batteries – and increasingly sophisticated capital goods, technology and AI… are the new growth drivers.

“China’s manufacturing competitiveness remains an important source of support to the economy, and is likely to be a bigger driver of growth than the consumer,” he added. Domestic consumption, by contrast, “while strategically important, is currently weaker, weighed down by the continuing softness in property impacting consumer confidence”.

This dual-speed economy is evident in funds investing in the region. While returns from the Chinese stock market have, as a whole, been pretty miserable over the last 12 months, some funds have delivered excellent returns. The gap between the top and bottom performing funds in the IA China sector is 64% over three years. Top-performing funds such as the T. Rowe Price China Evolution Equity Fund or JPM Greater China Fund have risen more than 50% over that period, but the weakest funds are under water.

Targeting innovation

China has seen the same boom in AI infrastructure spending as the US. It is now becoming increasingly competitive with the US, albeit with a different model. Its AI is open-source, meaning it can be used and adapted by anyone. This makes it different from US AI, which is owned by individual companies. China doesn’t have the sophisticated ‘frontier’ models for AI, such as those from Anthropic, but these aren’t necessary for many of the hoped-for productivity gains from the new technology.

Mackintosh-Whyte, for example, is gaining exposure to AI growth through cloud provider Alibaba (NYSE:BABA).

“It gives exposure to Chinese cloud, enterprise AI and model adoption, which has its own chips and around 10,000 enterprise large language model (LLM) clients,” he says.

He also has exposure through non-US listed companies with significant Chinese businesses. “ASML (AMSTERDAM:ASML) and Applied Materials (NASDAQ: AMAT) are names we own who produce products which are part of the semiconductor supply chain where China is an important end market. We have copper exposure – directly and via owning Freeport-McMoRan (NYSE:FCX) – where the Chinese investment in the electricity grid is driving significant demand for the metal.”

Dale Nicholls, portfolio manager of Fidelity China Special Situations (LON:FCSS), says it is still early days on AI investment and there will be winners and losers, but initial signs for many of the large platforms – TenCent (HK:700), Alibaba and Bytedance – is positive.

“Encouragingly, we are seeing them become more disciplined elsewhere, reducing losses in highly competitive areas such as food delivery while directing more capital towards AI infrastructure, cloud and applications that could strengthen their long-term competitive position,” said Nicholls.

Nevertheless, as in the US there are some worries over the potential for an AI bubble. Valuations in AI companies in China may not be as stretched as their US peers, but they have been subject to similar excitement. With that in mind, Nicholls is seeking less obvious routes into the Chinese innovation trade.

He expects the next phase of adoption to extend beyond digital applications into physical or ‘edge AI’.

“Robotics, autonomous driving, smart devices and wearables should become increasingly important as intelligence is embedded directly into products and services,” he says. He holds robotaxi group Pony.ai (HK:2026) in the portfolio.

Looking beyond AI, Nicholls also holds battery pioneer CATL (HK:3750). While the electric car market looks saturated and most companies are unprofitable, CATL should be a major beneficiary of the electrification trend. It is also moving beyond cars, leveraging its capabilities in energy storage systems to capture growing demand from the AI infrastructure buildout.

“As AI deployment increases electricity requirements, we see opportunities across the wider power ecosystem,” said Nicholls.

Roderick Snell, manager of the Baillie Gifford Pacific Fund, is investing in some direct AI beneficiaries, such as Mech-Mind (HK:9615), a company that develops 3D machine-vision systems – effectively the eyes of robots. However, he is also investing in energy, resources and construction companies that will benefit from demand for power infrastructure and critical materials, both from AI and from the electrification of China’s economy.

How can you invest in China?

A low cost route to access China’s stock market would be through an index-tracking fund or exchange-traded fund (ETF). The HSBC MSCI China UCITS ETF (LON:HCHA), for example, would give investors a decent weighting in Alibaba and TenCent. The problem is that it also gives access to a lot of ‘old economy’ Chinese companies. It has just 11% of assets invested in technology as of 30 September, with higher weightings in consumer and financial companies. Like the broader Chinese stock market, it has fallen over the past 12 months.

Paul O’Neill, chief investment officer at Bentley Reid outlines a possible alternative: “We own the Amundi Core MSCI China A Swap ETF (LON:C027). It tracks the MSCI China A index, which covers large and liquid A-shares listed in Shanghai and Shenzhen, priced in RMB.” The ETF’s top holdings include CATL and chipmaker Cambricon (SHANGHAI:688256). The ETF mixes battery and AI hardware leaders with banks, insurers and utilities.

“The top ten are only about 18.5% of the fund, and it is diversified across roughly 400 stocks,” said O’Neill.

Active funds may provide more targeted exposure to China’s new innovation economy. The Baillie Gifford Pacific fund, for example, has 48% of assets invested in technology, with only negligible amounts in areas such as real estate. The Allianz China A-Shares Equity Fund focuses on ‘created in China’ industrial and technological advances.

The innovation story in China is every bit as powerful as that of the US. There are industries where China is leading the world and it looks increasingly competitive in areas such as AI. Investors have plenty of options to target this part of China’s economic growth story, while ignoring its sluggish, legacy industries.