China's Innovation Story Is Strong, but Your Fund Choice Decides What You Own

China's most eye-catching tech headlines are hard to ignore. CATL's latest battery pack is said to offer up to 1,500km on a single charge, with 520km of range added in just five minutes. BYD has built a vehicle-mounted drone platform. On paper, an average Chinese electric car driver could make the Beijing to Shanghai trip on one charge while getting food deliveries along the way. Whether every claim plays out on the road is another matter, but the direction is clear.

China reportedly files around four times as many patents as the US, and it leads in robotics, clean energy technology and electric vehicles. It's also closing the gap with the US in artificial intelligence. Yet the economic dashboard looks much gloomier. Retail sales have barely grown over the past 12 months, the housing market keeps sliding, and deflation hangs over prices. Some industries have huge overcapacity, partly because of state subsidies and weak demand in key export markets such as the US.

Two economies in one market

That split is what makes China hard to pin down for investors. The stock market has real breadth, and it contains both the innovation leaders and a long tail of state-owned enterprises that are run with national goals in mind, not necessarily shareholder returns.

Will Mackintosh-Whyte, who runs multi-asset portfolios at Rathbones, reads this as a shift in the growth model. Property and infrastructure no longer carry the economy the way they used to. In his view, advanced manufacturing (semiconductors, automation, robotics, machine tools, EVs and batteries) and more sophisticated capital goods, technology and AI are the new engines. He expects manufacturing competitiveness to drive growth more than consumers do, with domestic spending held back by weak property and shaky consumer confidence.

The divide shows up clearly in fund returns. Over the past 12 months the Chinese market has, as a whole, performed poorly, yet some funds have done very well. In the IA China sector, the gap between the best and worst performers reached 64% over three years. The top funds, including the T. Rowe Price China Evolution Equity Fund and the JPM Greater China Fund, rose more than 50% over that period, while the weakest sat under water. That spread is the practical lesson: in China, the fund you pick matters far more than the country label on it.

Where AI fits in

China has seen an AI infrastructure spending boom similar to the US, but its model looks different. Its AI is largely open-source, so anyone can use and adapt it. US AI tends to be owned by individual companies. China doesn't yet have the cutting-edge frontier models that US firms are known for, but many of the productivity gains businesses are hoping for don't require them.

Dale Nicholls, portfolio manager of Fidelity China Special Situations, says AI investment is still early. He expects winners and losers, but the early signs look good for large platforms such as Tencent, Alibaba and ByteDance. He's encouraged that these firms are becoming more disciplined, cutting losses in fiercely competitive areas like food delivery and pushing more capital into AI infrastructure, cloud and applications.

There are worries here too. Some observers see a possible AI bubble, and Chinese AI valuations, while less stretched than in the US, have been swept up in similar excitement. That's one reason Nicholls looks for less obvious routes. He expects the next phase of adoption to move from software into physical or "edge" AI, covering robotics, autonomous driving, smart devices and wearables. His portfolio includes robotaxi group Pony.ai and CATL, which he sees as a beneficiary of electrification and of the power demand created by AI data centres, even as the electric car market looks crowded and many carmakers remain unprofitable.

Roderick Snell, who manages the Baillie Gifford Pacific Fund, takes a two-pronged approach. He holds direct AI players such as Mech-Mind, which builds 3D machine-vision systems, and also backs energy, resource and construction companies that should gain from demand for power infrastructure and critical materials. Those materials include the electrification of China's economy as well as AI.

Ways to get exposure

The cheapest route into China's stock market is usually an index-tracking fund or exchange-traded fund (ETF). The HSBC MSCI China UCITS ETF gives a meaningful weighting to Alibaba and Tencent, but it also carries a lot of older economy companies. As of 30 September, only about 11% of its assets were in technology, with bigger weightings in consumer and financial firms. Like the wider market, it has fallen over the past 12 months. If your goal is specifically to ride the innovation theme, that mix may not match.

Paul O'Neill, chief investment officer at Bentley Reid, points to a different structure. His firm holds the Amundi Core MSCI China A Swap ETF, which tracks the MSCI China A index. That index covers large, liquid A-shares listed in Shanghai and Shenzhen and priced in renminbi. Its top holdings include CATL and chipmaker Cambricon, but it also holds banks, insurers and utilities. O'Neill notes that the top ten holdings make up only about 18.5% of the fund, spread across roughly 400 stocks. Diversification is a real benefit here, but it also means the innovation stocks are only one part of the picture.

Active funds are the other option if you want a sharper tilt. The Baillie Gifford Pacific Fund holds about 48% of its assets in technology and very little in real estate. The Allianz China A-Shares Equity Fund focuses on "created in China" industrial and technology advances. Active funds can differ sharply in results, as the 64% performance gap shows, and their managers' choices can go wrong.

What to weigh before you buy

Here's the thing: the innovation case is strong, but it doesn't remove the risks. Property weakness, deflation, export exposure and overcapacity could all hit companies hard, and political and market rules can shift without much notice. Past returns don't guarantee future ones, and the funds and stocks named here are examples of what managers hold, not recommendations. Before you invest, check what a fund actually owns, how concentrated it is, and whether its costs and risks suit your own situation. For personal guidance, a qualified adviser is the better route.

My read is that China's innovation story is real and worth understanding, but the sectors it covers and the funds you choose will shape your experience far more than the headlines. Start by looking under the bonnet of any fund before you assume it gives you the tech exposure you're after.