The China Paradox
Why China’s industrial strength rarely translates into shareholder value
On a recent research trip to China, we met with company executives and toured operating facilities across several of the country’s largest businesses. The experience reinforced China’s unquestionable importance to the global economy, and why we continue to monitor Chinese equities for selective opportunities.
What stood out most was the contrast: China is accelerating toward technological leadership in AI, robotics, and electric and autonomous vehicles. Yet across many sectors, the structure of competition and capital allocation has made sustained shareholder returns elusive. The challenge for investors is separating disciplined operators from competitors that aim for market share above all else, eroding margins. As a result, we remain highly selective in our approach to Chinese equity ownership.
Below are some observations from the trip.
Property-Constrained Consumption
With home prices down more than 40%, the property collapse continues to reverberate across the economy. Shockingly, it would take a fall of roughly the same scale to lift rental yields to levels typical in developed markets.
Before the downturn, roughly 70% of household wealth was tied to property. Against that backdrop, the government’s strategy of a managed property decline is unlikely to revive consumption meaningfully until a prolonged balance sheet repair has run its course. And with few credible routes to building real wealth - equities are often hard to access, highly volatile, and not always kind to minority shareholders - higher precautionary saving is rational.
China’s enormous household savings are largely absorbed by a relatively closed financial system that prioritises industrial and strategic objectives, limiting the transmission of household wealth into broader consumption growth and durable shareholder returns.
The “Involution” Trap
China’s state-directed model continues to produce technological marvels, but often within industry structures that struggle to sustain shareholder returns. Top-down growth targets and subsidies encourage a proliferation of competitors who fight for survival in what the locals call “involution” – a race to the bottom in pricing and returns. Pricing pressure intensifies, returns compress, and survival takes precedence over capital discipline.
In this environment, value is allocated unevenly. Consumers benefit from lower prices and rapid feature adoption, officials meet employment and output targets, and industrial capacity continues to expand. Shareholder get the short end, with profitability structurally constrained. Inevitable overcapacity is pushed into export markets, contributing to rising geopolitical friction.
The electric vehicle ecosystem captures both the strength and the tension in this model. China now has automotive manufacturing capacity sufficient to meet roughly half of global demand, while domestic sales require only a fraction of that output. The result is intense competition and falling margins, with premium features increasingly bundled at little or no incremental cost.
Exceptional companies do emerge. Xiaomi’s rise from zero to an annualised production run-rate of roughly 500,000 vehicles in under 18 months is remarkable. Its highly automated factory produces vehicles comparable to Western standards at approximately $25,000 per unit. The broader lesson, however, is that China’s manufacturing base is so deep and capable that competing with its exports, even from less well-managed firms, will remain challenging regardless of tariff regimes.
“Involution” is not limited to industrials. Alibaba continues to compete aggressively for share across multiple business lines. Even in cloud computing, where it has built a sophisticated full-stack platform, margins remain modest. This reflects an industry structure shaped by state-supported competition, where pricing power and returns are structurally limited rather than operationally mismanaged.
Autonomy, Robotics, and Compute Constraints
We took a robotaxi ride, underscoring how close urban autonomous driving is to becoming a solved technological problem. While the unit economics remain uncertain, the direction of travel is clear. Transport is likely to change meaningfully over the coming decade. Humanoid robotics is also advancing rapidly toward commercial viability, driven by EV companies hardware expertise and improving software capability.
The most consistent theme we experienced was the significant investment flowing into AI, robotics, and semiconductors. This is aimed at alleviating the reality that access to high-performance compute is the binding constraint to modern technological progress. This context helps explain the intensity of Western hyperscaler capital spending, which increasingly appears rational rather than excessive.
Relative scarcity of advanced compute highlights the strategic importance of semiconductor access. It also creates a strong incentive to develop domestic alternatives. NVIDIA remains the dominant supplier today, but Western leadership in advanced compute cannot be taken for granted.
Where We Found Quality
Tencent, a long-held position in our portfolio, stood out as a rare example of a shareholder-aligned compounder. Management is allocating scarce high-end AI compute to the highest-return applications across its existing businesses, rather than pursuing capital-intensive, low-return consumer AI initiatives.
This disciplined capital allocation should help preserve Tencent’s distinctive return profile as AI gradually augments both growth and profitability.
Where To From Here?
China’s industrial transformation is extraordinary, and export growth is likely to persist despite rising geopolitical friction. But for equity investors, attractive returns are likely to remain concentrated in a narrow set of disciplined, shareholder-aligned operators.
The ongoing property correction points to structurally weak consumption in the absence of meaningful policy intervention. China’s economic model excels at delivering national strategic objectives, but it remains a challenging market for sustained shareholder value creation.
We will continue to patiently comb Chinese equities, seeking out businesses that align with our quality philosophy and offer the potential for attractive long-term returns.
