- After decades of fast economic growth, China started to shift its development focus from export and fixed-asset investments to domestic consumption and technological innovation.
- Technological innovation has been embedded in many sectors and across the whole product and service life cycle as China has emerged as a global leader in technology and the digital ecosystem.
- A traditional single-sector-based approach hits hard limits trying to gain exposure to technologies transforming activities as diverse as consumption, mobility, automation and health-care services.
China enjoyed high levels of economic growth during the past 40 years, making it the second-largest economy in the world since 2010. However, China’s GDP growth has slowed since 2011 compared to the first decade of the 2000s.1
Cutting overcapacity2 and finding new areas of growth have been the top priorities for the Chinese authorities. During the past few years, technological innovation was identified as a key enabler to transform China’s economy into a dynamic, robust and sustainable economy.3
Technological Innovation in China — A Long-Term Trend
China is rapidly emerging as a leader in technology across various sectors. This could have significant implications for investors seeking exposure to this powerful trend. The research-and-development (R&D) spending behind technological innovation is a key indicator to watch. As shown in the exhibit below, China’s overall R&D spending in 2018 was USD 463 billion, second only to the U.S. However, the cumulative five-year growth rate of China’s R&D spending was 49%, which is 16% higher than that of South Korea, which had the second-highest growth rate. Strong growth in R&D spending is supported in coming years as, despite increases, the overall level of R&D spending to GDP in China is still lower than in many countries.
R&D Spending Growth and as a Percentage of GDP
Bubble size represents R&D expenditures in USD million. Source: OECD.
However, companies in the technology value chain are found not just in information technology, but scattered across many traditional industries, including industrial automation and robotics, medical devices, autonomous and electric vehicles, green energy and new materials. All these industries were supported by a recent government-investment program aimed at delivering more growth opportunities.4
This diverse industry representation poses a challenging question for investors: How do you capture the full exposure of China’s emerging technological-innovation and digitalization value chain — or, in simpler words, China’s new economy?
An Indexed Approach to Capture Broader Exposure to Chinese Tech
To mitigate the limitations of a traditional sector-based approach, we studied a novel alternative approach as a way to gain broader exposure to Chinese companies in innovative industries with core technology across a range of sectors. Compared to the traditional tech-investing approach that selects securities based on the Global Industry Classification Standard (GICS®),5 taking the alternate approach — which is sector-agnostic — could capture a broader exposure across multiple industries and sectors including mobility, internet, health care, consumer discretionary and communication services. To demonstrate the key characteristics of this approach, we simulated sector-agnostic multi-thematic indexes by selecting stocks that had a high exposure to a select set of technology-focused business activities.6 The simulated indexes included companies exposed to the technological-innovation and digitalization value chain, in addition to the traditional information-technology companies.
Key Characteristics of a Sector-Agnostic Approach to Chinese Tech
The exhibit below illustrates the multi-thematic characteristics of our approach where the constituents of our simulated index are exposed to a diverse set of business activities. The target business activities or sub-themes can be expanded and evolved to reflect the development of technology innovation over time.
Sub-theme Exposure of MSCI China Tech 100 Index
The number above each bar represents the number of constituents within each sub-theme. The Y-axis shows the weight of the sub-theme in the index. Because stocks can be exposed to multiple business activities, the total number of stocks is greater than 100.
Further, as shown in the exhibit below, in addition to the information-technology sector, the index also selects, significantly, from communication services, health care, industrials, consumer discretionary and materials.
Breakdown by GICS Sector of MSCI China Tech 100 Index
From the perspective of factor exposures, a multi-thematic approach demonstrated a higher exposure to growth and momentum factors relative to both the parent index (MSCI China Index) and sector-based information-technology index (MSCI China Information Technology Index) by using MSCI FaCS™ analysis, as shown in the exhibit below.
Factor Exposure of MSCI China Tech 100 Index
China’s shifting economic focus to technology and innovation may bring significant opportunities to both domestic and international investors. Understanding the multi-sector nature of China’s technology value chain could be an important consideration for investors seeking balanced exposure to this emerging growth area. A multi-thematic approach could serve as a complementary tool to aid investors considering exposure to Chinese tech.
1Although China’s GDP growth is still leading the world, real growth decreased from an average of 10.4% per annum between 2000 and 2010 to 7.4% per annum during 2011-2019.
2On one hand, government spending and an economy centered on state-owned enterprises eventually created overcapacity, especially in traditional sectors of the economy, such as manufacturing, energy and materials. On the other hand, the inflation in labor costs forced the labor-intensive industries to shift from the “world’s factory” to other emerging and frontier markets. According to the U.S. Department of Commerce, labor costs in the manufacturing sector of China almost tripled from 2000 to 2016.
3“China to reform old, boost new growth engines." 2016. China.org.cn
4Recently the Chinese government backed a master plan to invest up to USD 1.4 trillion until 2025 in technologies and products to support the growth of autonomous driving, automated factories and smart manufacturing. See, for example: “China has new US$1.4 trillion plan to seize the world’s tech crown from the US.” South China Morning Post, May 21, 2020.
5GICS is the global industry classification standard jointly developed by MSCI and Standard & Poor’s.
6For more detail, see “MSCI China Tech 100 Index” MSCI, December 2020.