BAILLIE GIFFORD

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Baillie Gifford China Fund Quarterly Update 31 December 2021

This document contains information on investments which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned. Investment markets and conditions can change rapidly and as such the views expressed should not be taken as statements of fact nor should reliance be placed on these views when making investment decisions.

This document is issued by Baillie Gifford & Co Limited, Calton Square, 1 Greenside Row, Edinburgh EH1 3AN, a company which is authorised and regulated by the Financial Conduct Authority, Financial Services Register No. 119179, and is a member of The Investment Association. Baillie Gifford & Co Limited is wholly owned by Baillie Gifford & Co, which is authorised and regulated by the Financial Conduct Authority.

The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.

As with any investment, the clients’ capital is at risk. Past performance is not a guide to future returns.

Throughout the report all figures are rounded, so any totals may not sum.

All information as at 31 December 2021 and source is Baillie Gifford & Co unless otherwise stated.

Baillie Gifford & Co Limited Calton Square, 1 Greenside Row, Edinburgh EH1 3AN Telephone +44 (0)131 275 2000 bailliegifford.com

Copyright © Baillie Gifford & Co 2009 Ref: 14573 10006550

Executive Summary 01

Fund Objective

To outperform (after deduction of costs) the MSCI China All Shares Index, as stated in sterling, by at least 2% per annum over rolling five-year periods. The manager believes this is an appropriate target given the investment policy of the Fund and the approach taken by the manager when investing. In addition, the manager believes an appropriate performance comparison for this Fund is the Investment Association China/Greater China Sector. There is no guarantee that this objective will be achieved over any time period and actual investment returns may differ from this objective, particularly over shorter time periods.

Risk Analysis

Key Statistics

Number of Holdings 62

Typical Number of Holdings 40-80

Active Share 70%*

Annual Turnover 33%

*Relative to MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index to 26/11/19 thereafter MSCI China All Shares Index. Source: Baillie Gifford & Co, MSCI.

Chinese regulatory change has had a profound impact on the investment environment, though we believe a lot of this change is positive for the long term Drawing conclusions from headline stock market performance risks missing the significant divergence underneath this The size of China's markets and the speed of its growth and technological leadership are giving rise to significant opportunities

Commentary 02

Two vaccinations and a booster later and now we’re worrying about Omicron? The use of the Greek alphabet for labelling was intended to be simpler than using their scientific names, as well as preventing people from referring to variants by the location of where they were detected. In jumping from Mu to Omicron, the World Health Organisation (WHO) missed out two obvious letters. ‘Nu’ was reportedly skipped over for clarity to avoid being too easily confounded with ‘new’. ‘Xi’ was apparently avoided given it is a common last name and could cause wider offence.

One specific Mr Xi has clearly had a big impact in 2021. China’s drive to greater common prosperity and implications for regulatory oversight of key areas of the economy have dominated headlines and made for a difficult year for investors in China. In controlling local-government debt, limiting borrowing by property developers, tightening regulation of internet platforms, as well as new political campaigns on inequality and family values, we have seen China focusing on long-term sustainable goals at the expense of short-term growth. To us, this may not be a bad thing, given a shift in focus from growth at all costs to quality sustainable growth. But for a market often highlighted for high turnover and its short-term focus, changes to quarterly earnings and negative news flow are likely to be met with selling pressure.

Against this background, it is important not to lose sight of the long-term structural and disruptive changes that are likely to play a far larger role in portfolios. For growth investors focused on that long-term horizon, then China’s continued urbanisation, consumption upgrade and reform, and rapid development in innovation and technology continue to provide much scope for optimism. Yet, this needs to be carefully balanced with concerns about the role of the state, the direction and speed of regulatory change, and overarching geopolitical and ideological concerns. Broad generalisations about China are typically unhelpful.

Plenty of ink has been spilt here and indeed everywhere on China’s regulatory developments. It is clearly a complex topic that has both domestic and geopolitical components. It requires an assessment of the degree to which regulations are driven by politics versus a genuine concern for the development of healthy industries and protecting consumers (opening walled gardens for payments, insuring delivery drivers, labour rights, data security etc). Although it is often easy to assume greater political intent, as is common in western media reporting, many of these regulatory changes are things we’ve all been arguing for in recent years – greater labour rights, data privacy, a focus on sustainability. The reality is that big tech is under the microscope globally because of its growing influence, and regulators

© John Lamparski/Getty Images.

Commentary 03

are struggling to balance the equilibrium between innovation and regulation. For better or for worse, the difference is that China’s system of government allows it to act faster.

In summary, we think we are probably through most of it; a lot of it is sensible; companies have been quick to adapt. In some cases, regulation has likely reduced the probability of the most extreme upside growth case, but we remain comfortable that the companies in the portfolio can still meet our hurdle of doubling clients’ money over the next five years. The long-term opportunities remain, and regulatory volatility is part of the landscape that we need to accept along with the big opportunities. Indeed, those that heed the regulatory warnings may go on to thrive in a tighter and more predictable regulatory environment.

Nonetheless, we continue to expect companies on the ‘three mountains’ of property, education and healthcare to face regulatory scrutiny over whether their profits are justified. Taking a long term, active and engaged approach allows us to avoid broad generalisations about the role of the state or environmental, social and governance (ESG) matters, and focus specifically on the core drivers of individual companies and their sustainable growth opportunities. Semiconductors, advanced materials, and alternative energy have regulatory tailwinds as China looks to improve its self-sufficiency in these areas, though local markets have shown themselves to be enthusiastic and often undiscerning in applying heady valuations to these sectors. We continue to scour the A share market carefully for potential beneficiaries.

Technological innovation is most crucial for furthering China’s development. Innovation is difficult to measure, but if using patent applications as a substitute, China has been driving growth in recent years. With digital regulation ongoing, there is an argument that Beijing is seeking to reorient China’s focus of innovation into its hardware and manufacturing capabilities, further developing the ‘infrastructure of the future’. Investing in China’s industrial upgrading remains full of opportunities, many of which are only found in China’s A share market.

Moreover, we expect increasing efforts to address climate change, realise carbon neutrality and pursue sustainable development in the next five to ten years, have the potential to drive a new industrial revolution. China has highlighted a commitment to peak CO2 emissions before 2030 and carbon neutrality before 2060.

Addressing climate change and promoting carbon neutrality may present both challenges and opportunities for China. We hope that a new relationship with the China-UK Low Carbon College at Shanghai Jiaotong University is going to provide deeper insights to help us navigate this transition.

Consumption and service upgrading is also expected to provide significant opportunities. China is expected to become the single-largest consumer market in the world in coming years. We recently published an in-depth report on China’s Generation Z+ consumers, who we expect to be the major driving force of this consumption upgrade. This group alone is approximately 450 million people, far larger than the entire US population. It is impossible to know for sure which Chinese companies will be propelled to success by this up-and-coming cohort, but the sheer size and curious nature present exciting opportunities to those who are willing to engage in deep research, focus on growth and patiently give companies time to mature.

Looking in the rear-view mirror does little to help us see into the future. In little under a decade, China has gone from a follower to a leader in many areas. It will remain a complex market, with investors attracted by the speed of its growth and the size of its markets, yet perplexed and challenged by the role of the state, China’s increasingly assertive geopolitics, its disclosure levels and ESG impact. Avoiding broad market or index generalisations is important. We believe that good companies aren’t made overnight. Secular and disruptive trends take years if not decades to play out. Our philosophy has always been to find the highest growth companies in China and hold them for the long term for our clients. The current market environment does nothing to change this approach. So perhaps there is some irony in the fact that the WHO missed out both ‘new’ and ‘Xi’ in their etymology. From our standpoint of seeking exciting growth companies, China is developing fast and we remain excited about the opportunities that 2022 will bring.

“A talent for following the ways of yesterday”, declared King Wu-ling in 307 BC, “is not sufficient to improve the world of today.” PETER FRANKOPAN, THE SILK ROADS: A NEW HISTORY OF THE WORLD

Commentary 04

Performance commentary

While stock specifics typically dominate performance attribution, this quarter was notable for thematic drivers, with government policy being key. Sectors with clear policy support, such as industrial upgrading and renewable energy performed well, while growing regulatory concerns impacted performance across the healthcare space.

EV battery manufacturer, CATL, continued its strong performance. The rising noise around environmental issues, particularly amongst governments and reflected during the quarter at COP26 in Glasgow, has focused people on the large addressable market and growth prospects for companies in the sector. CATL is building its global leading market share on the back of its innovation, cost advantages and significant capacity expansion. During the quarter, the company committed to further investment in its battery capacity, which is expected to triple over the next three years, as well as signing a new supply contract with a large domestic EV auto business.

The industrial sector had a relatively strong quarter given a perceived shift in policy focus towards industrial automation and domestic productivity. Industrial automation product manufacturers Shenzhen Inovance and Zhejiang Sanhua Intelligent Controls, and auto component maker Huayu Automotive were also significant contributors to performance.

In contrast, greater fears of regulatory oversight and pricing pressure in the healthcare sector weighed on performance. Healthcare is an area with concerns about future regulation, though we believe it is important to distinguish between those companies that look closest to the firing line and those that are innovating to provide solutions to significant problems, that if successful, will be positive contributors to the wider common prosperity goal.

To take Zai Labs as one example, this is an oncology drug development business where, despite recent volatility, we see their core purpose to be very positive and see three key competitive advantages that remain: 1. the company has very strong partnerships with leading overseas healthcare companies allowing them good technology and talent access; 2. they have very high levels of expertise and are one of very few biotechs in China to do all clinical work inhouse; 3. commercial execution – the management team have a proven track record.

Although share prices were weak in the sector, many healthcare companies continued to report strong earnings growth. Domestically listed dental operator, Topchoice, was a significant detractor to performance in spite of exceeding growth expectations. We expect that long-term earnings growth will be rewarded once the spectre of regulatory pressure in the sector has died down. The investment case here is driven by long-term trends. Dental penetration rates in China are low and dental costs are not covered by the state’s healthcare reimbursement scheme. Over time, we expect a more health-conscious population with improved purchasing power to support greater consumption of dental services.

China has been volatile this year and it seems that at least some of the top individual contributors in one quarter then feature among the individual detractors in the following quarter and vice versa. That was again the case during this quarter. In truth this doesn’t tell us much about the long-term outcomes of the companies in which we have invested in for our clients. From an operational standpoint, there often appears little difference between any given quarter’s ‘winners’ and ‘losers’. This lack of discrimination by the market may last a while, but experience has taught us to focus on fundamentals and ride out these relatively short-term bouts of volatility in order to secure good long term returns for our clients.

The views expressed reflect the personal opinion of the

author and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Performance 05

Periodic Performance

3 Months 1 Year

3 Years (p.a.)

5 Years (p.a.)

Class B-Acc (%) -4.1 -17.7 18.5 15.1

Index (%)* -3.0 -12.0 10.0 9.7

Target (%)** -2.5 -10.2 12.2 11.9

Sector Average (%)*** -2.8 -10.7 13.4 11.2

Performance source: FE, StatPro, MSCI, total return in sterling. *MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index to 26/11/19 thereafter MSCI China All Shares Index. **Target refers to Target Benchmark: MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index +2% to 26/11/19 thereafter MSCI China All Shares Index +2%. ***IA China/Greater China Sector.

Discrete Performance

31/12/16-31/12/17

31/12/17-31/12/18

31/12/18-31/12/19

31/12/19-31/12/20

31/12/20-31/12/21

Class B-Acc (%) 49.2 -18.6 29.6 55.9 -17.7

Index (%)* 31.7 -9.3 16.8 29.5 -12.0

Target (%)** 34.3 -7.4 19.1 32.1 -10.2

Sector Average (%)*** 35.9 -14.2 22.2 33.6 -10.7

Performance source: FE, StatPro, MSCI, total return in sterling. *MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index to 26/11/19 thereafter MSCI China All Shares Index. **Target refers to Target Benchmark: MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index +2% to 26/11/19 thereafter MSCI China All Shares Index +2%. ***IA China/Greater China Sector.

Performance 06

Stock Level Attribution

Top and Bottom Ten Contributors to Relative Performance

Quarter to 31 December 2021 Stock Name Contribution (%)

CATL 0.4

Wuxi Biologics Cayman Inc 0.3

Huayu Auto Systems 'A' - Stock 0.3

Estun Automation 'A' - Stock C 0.3

Shenzhen Inovance Technology 0.2

Sanhua Intelligent Controls 'A 0.2

Proya Cosmetics 'A' - Stock Co 0.2

Sunny Optical Technology 0.2

Minth Group 0.2

Haier Smart Home 'H' 0.2

Zai Lab ADR -0.5

Topchoice Medical Investment ' -0.4

WuXi AppTec 'H' -0.4

Bilibili -0.4

BeiGene -0.4

Burning Rock Biotech Ltd ADR -0.3

Hangzhou Tigermed Consulting ' -0.3

Medlive Technology Co Ltd -0.3

China Molybdenum 'H' -0.2

Alibaba -0.1

One Year to 31 December 2021 Stock Name Contribution (%)

CATL 1.6

Li Ning 1.4

Asymchem Laboratories 'A' - St 0.8

China Merchants Bank 0.7

TAL Education Group ADR 0.6

New Oriental Education & Techn 0.5

XIAOMI CORP B 0.5

Sunny Optical Technology 0.4

WuXi AppTec 'H' 0.4

NIO Inc ADR 0.3

Ping An Insurance -0.9

Yatsen Holding Ltd ADR -0.9

Alibaba -0.7

Kuaishou Technology -0.6

Bilibili -0.5

Pop Mart International Group L -0.5

Lufax Holding Ltd -0.5

Zai Lab ADR -0.4

HUYA ADR -0.4

Burning Rock Biotech Ltd ADR -0.4

Source: StatPro, MSCI. Baillie Gifford China Fund relative to MSCI Golden Dragon Index to 02/05/2019, MSCI All China Index to 26/11/19 thereafter MSCI China All Shares Index. Some stocks may have been held part period.

Portfolio Overview 07

Top Ten Holdings

Stock Name Description of Business % of Portfolio

Tencent Internet service portal 8.8

Alibaba Online commerce 6.8

CATL Battery manufacturer 4.9

Meituan Chinese online services platform 4.2

Kweichow Moutai Spirits manufacturer 4.1

JD.com Largest online direct sales company in China 4.0

China Merchants Bank Chinese bank 3.2

Ping An Insurance Provides insurance services in China 3.2

Li Ning Chinese sportswear 2.8

Shenzhen Inovance Technology Industrial machinery manufacturer 2.1

Total 44.1

Sector Weights (%) 1 Consumer Discretionary 30.6

2 Communication Services 14.0

3 Industrials 13.2

4 Health Care 12.5

5 Financials 8.6

6 Information Technology 8.3

7 Consumer Staples 7.2

8 Materials 3.7

9 Utilities 1.3

10 Real Estate 0.4

11 Cash 0.3

A negative cash position may sometimes occur due to obligations awaiting settlement.

1

2

3

4

5

6

78

Governance Summary 08

The importance of context and time

The Edison Illuminating Company, established by the engineer Thomas Edison in December 1880, built the first commercial electrical power plant in the United States at Pearl Street, Manhattan. As the facility also produced steam to heat neighbouring buildings, it was the world’s first cogeneration plant, creating both heat and power. The station provided electricity for an initial 400 lamps, including electric street lighting for Pearl Street, the first thoroughfare in the US to be illuminated with grid electricity. From the outset, the new utility company was able to compete on price with the incumbent gas lighting technology of the day, although before generation could start in earnest and before bills could be issued to their new customers, the company had to invent the first electricity meter to monitor consumption. Due to its significance in the development of the electrical utility sector and many other parts of the economy, a scale model of the Pearl Street station is housed in the Smithsonian National Museum of American History in Washington.

While taking a long-term perspective is fundamentally important for growth investing, it is arguably even more important with respect to evaluating the economic, social and environmental impact of a company. One of the many limitations of the standard industry approach to ESG (environmental, social and governance) is that it typically attempts to appraise a holding’s present-day performance on ESG using backward-looking data. Furthermore, there is a strong ESG industry bias towards focusing on governance and sustainability risks rather than opportunities. While this is understandable if the focus is on limiting financial and reputational downside risks, it won’t necessarily help to make the world more sustainable and equitable and may be entirely counter-productive. To use the above example of the Edison Illuminating Company, the ESG risk doubters would have been justified in having concerns about the new-fangled electric grid technology being developed by one of the most innovative and experimental engineering companies of the era – The Pearl Street Generating Station burned to the ground in 1890.

However, taking the long view, reliable and affordable grid electricity has been one of the most important drivers of social and economic development that the world has ever seen. To state the obvious, our entire modern healthcare and education system is built on the foundations of grid electricity, as well as most of the wider economy. There is a very close relationship between access to grid electricity and human development indicators in every region of the world, prompting the economist Jeffrey Sachs to cite access to electricity as the single most important global development priority in the decades ahead (clean grid electricity will also be a big part of the

Thomas Edison © Boyer/Roger Viollet/Getty Image.

journey to net zero emissions too, as it replaces all possible carbon-based fuels for heating, cooling and mobility applications). Even within a much shorter time frame, electrical lighting very quickly came to be safer and cleaner than the alternatives of the day, such as gas and oil-fired lighting.

In short, innovative, world-changing companies may be exposed to ESG risks, but they must be viewed in context and within a long-term perspective. Some ESG risks may be avoidable, but others may be inherent to the challenge (and opportunity) that the company is addressing. Fast-forwarding to the present day, risk-averse companies making incremental improvements to present day products and services are unlikely to make much of a contribution to getting the world to a more equitable net zero emissions economy in the next 28 years, or to addressing the most intractable human health challenges such as cancers and degenerative brain conditions. We need to understand the risks and challenges along the way (and push for improvements where appropriate), but keep a steadfast focus on the long-term opportunity arising from asking, ‘what might go right?’

Governance Summary 09

While there is absolutely a requirement for the asset management sector to ‘raise the bar’ on Environmental, Social and Governance issues across all holdings and asset classes, active managers in particular need to focus attention on identifying, nurturing and supporting the small cohort of transformational companies that have the potential to help us achieve a number of ever more pressing sustainability challenges, none more urgent than climate change. These disruptive companies can have a disproportionate impact on entire sectors, by forcing others to raise their game. Pioneering electric vehicle firms have had a direct impact on addressing climate change and reducing air pollution through the production of EVs that can be run on renewable energy, but this is dwarfed when compared to the role they have played in forcing the entire automobile sector to move on from the 100-year-old incumbent technology of the internal combustion engine.

In other areas of the ESG industry, there is an exponential increase in noise and activity, some of which is helpful but much of which is not. The number of engagements we have with the holdings per year for example tells us nothing about the quality and impact of these engagements. There is a very real danger that, driven along by country-level stewardship codes and the EU’s Sustainable Finance Disclosure Regulation (and comparable regulations), there is an enormous increase in ESG engagement with management teams – this may be helpful signalling to companies on the importance of ESG integration, but at an aggregate level may divert large amounts of management time and attention away from addressing the very challenges that are being discussed.

It is a very positive development that all financial services firms are thinking more about what it means to invest sustainably, but we need to be alert to the risk of increasing levels of ESG cognitive dissonance at best and hypocrisy at worst. From a responsible investment point of view, is it helpful to hold a consumer technology company but not the chip makers and miners, never mind the company that manufactures the products? The world currently depends upon a whole range of products and services provided by higher impact industrial companies. Supporting these companies in the transition to more sustainable technologies is every bit as important as holding clean technology leaders and low-impact services firms, so our bias should be towards engagement, rather than divestment, as we aim to be helpful long-term stewards.

Capitalism currently stands at something of a crossroads, and there is ever increasing activism in most countries for a model of development which is more sustainable, more inclusive, and more equitable in the decades ahead. However to support those very laudable goals while also focusing on long-term financial performance, investors need to be more thoughtful and discerning than ever, ensuring that they are research-led and analytical in everything that they do. At Baillie Gifford, our entire approach to ESG is based around investing in the capability to understand the pertinent challenges and opportunities in this area, and we look forward to sharing our growing work with interested clients.

Voting and Engagement Summary 10

Voting Activity

Votes Cast in Favour

Companies 13

Resolutions 59

Votes Cast Against

Companies 2

Resolutions 2

Votes Abstained/Withheld

Companies 3

Resolutions 7

While taking a long-term perspective is fundamentally important for growth investing, it is arguably even more important with respect to evaluating the economic, social and environmental impact of a company

One of the many limitations of the standard industry approach to ESG is that it typically attempts appraise a holding's present-day performance on ESG using backward looking data

Asset managers need to focus on identifying, nurturing and supporting the small cohort of transformational companies that have the potential to help us achieve a number of evermore pressing sustainability challenges

Company Engagement

Engagement Type Company

Corporate Governance Tencent Holdings Limited

Environmental/Social Bilibili Inc., Meituan, Shandong Sinocera Functional Material Co., Ltd.

Transaction Notes 11 Baillie Gifford China Fund

New Purchases

Stock Name Transaction Rationale

Zijin Mining Group Co Ltd 'H' Zijin Mining is a Chinese gold and copper company with ambitious volume growth plans through organic expansion and M&A, particularly in its copper business. Copper is an economically sensitive commodity that should benefit from economic activity globally but should be further boosted meaningfully by green investment (be it renewable generation or electric vehicles). Indeed, copper is an essential enabler of the green revolution. We do not think the upside to the commodity price, nor Zijin's growth potential, is being adequately factored in by the market and have therefore bought a position for the portfolio

Complete Sales

Stock Name Transaction Rationale

AAC Technologies Holdings We have decided to sell the small holding in AAC Technologies. Whilst the company has an excellent track record in developing new products for the smartphone market, we are concerned by the increasing competitive pressures from new entrants, particularly those in China. AAC has enjoyed excellent financial returns for many years but may now be under structural pressure. This, combined with healthy competition for capital, has led us to reinvest the proceeds elsewhere.

Ping An Healthcare & Tech Ping An Healthcare and Technology provides artificial intelligence assisted medical advice and online consultations with top-tier doctors. The investment case centred around China's lack of primary care and conflicting incentives with the hospital system. However, following new draft regulations, we have greater concerns about the future of the business. Proposed changes include the requirement for doctors to be real-name verified and not an AI substitute, as well as stricter regulation on the ability to use a downloaded prescriptions from the app. These changes signal a misalignment with the state and we have therefore decided to sell the holding.

Legal Notices 12

MSCI Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.