Does China Have an Advantage in the AI Race?

Brendan Ahern, CIO of KraneShares, provides insights into policy changes in China that could benefit investors, as well as how geopolitics have created very different China investing environments for U.S. versus non-U.S. investors. Ahern also delves into the AI race happening, and why developments in China could give it a leading edge. 

Transcript 

On the Ground in China

Nadig: All right, Brendan Ahern at KraneShares. You just got back from a trip to Asia, so I want to grill you a little bit about what's been going on over there. Obviously, big headlines last week and this week about realignment with China, which seems to have been like the story for the last, I don't know, decade. Give us a little bit of on the ground feedback about what's really different this time. Do you really think that we have reestablished terms in a way that are investible that are ways investors can really access some of these changes.

Ahern: Yeah, definitely. And it's great to reconnect, Dave. Yeah, I do think being in Asia, this was my seventh trip to Asia this year. And being in Singapore, you look out at the Strait of Malacca and all those cargo ships, all those LNG, all those oil tankers are coming to and from China, from the Middle East and Europe. And so a big part of the world is really geared to China economically.

And that includes the U.S., obviously, U.S. multinationals, a lot of them Tesla, Apple, a lot of China exposure. But I think for investing in China, we've had this long shadow of the geopolitical and negative media narrative that I think, as President Trump, really reestablishes diplomatic ties with China. It's going to overhang. And we're really seeing and experiencing that from non-US investors if it's in Europe, the Middle East, in Asia. But I do think that can happen for US investors as well.

Nadig: So a lot of the discussion about China has actually been very US centric, meaning like a lot of the discussion for investors has been tariff implications, general trade slowdowns. Are they buying enough of this? Are we no longer buying that?

But when we think about investing in China, that's not really what we're doing. We're kind of investing outside of that ecosystem. China hasn't had a great run lately in terms of its economic data, right? It's actually been in a period of deflation. How are you thinking about its positioning as its own economic entity outside its direct relationship with the U.S.?

Ahern: Yeah, I mean, the Chinese equities have been in a bull market since January of 2024. You know, and that's where we had this derivative induced meltdown that this capitulation that the markets really rallied since then. It's been higher highs and higher lows, but it's grinded higher. Certainly, we're seeing an opportunity in the markets. And yes, there are issues economically in China, most notably there.

Not the trade war, but actually their housing situation where housing prices have come down, that's weighed on consumer confidence, domestic consumption. But more importantly, we're seeing policies really to stimulate the consumer. They're doing subsidies for consumption in auto, electronics, home appliances. We just got the draft of their 15th five-year plan.

So this is their economic blueprint and as investors, we want to align ourselves with this government policy and certainly raising domestic consumption is a component. We also see a lot of emphasis on science and technology. So yeah, we certainly see there's an opportunity for investors to come back into the China waters to dip our toes there. And we are seeing this re-rating of Chinese equities happening from investors globally.

China's Domestic Policy Changes A Positive for Investors

Nadig: So part of the story, as you said, is the stimulus for the Chinese consumer, right? The local market there. But there's also been some what from a U.S. perspective, which feels a little bit like heavy handed industrial policy changes to particularly around things like the solar industry or other pieces of technology where internal competition has actually been kind of bad for some of those companies. And a product that like you guys run KWEB, the China internet and China web technology ETF – that's clearly exposed to a lot of those kinds of companies. Do you see that their prospects from an industrial policy perspective? Is that really going to change their earnings profile and how investors think about them over the next year or so?

Ahern: Yeah, it's a great question. In China in July, we had this article published by, from President Xi talking about they call it anti involution that that's addressing excess capacity, excess competition, where you have these pirate victories where these companies just basically kill each other to garner market share and they singled out solar, auto, steel, cement. They actually mentioned the e-commerce, but it's really solar is where we're really seeing this first, Dave.

Right after that July 1st, they pulled in all of the major solar companies. These are the global leaders, but they don't make any money. Since that meeting, they've agreed to curtail production. Polysilicon futures in China went basically straight up. And most recently during the Q3 earnings cycle, the two global leaders in terms of solar panel production, Tongwei and Longi, who have always grown top line, they make revenue, but they actually dramatically reduced their losses in Q3. So we're just seeing this first effect of this anti-involution in solar and I think we can see that applied to other industries.

We hear a lot about China makes too many cars, too many electric vehicles and so we're seeing this first effect and I think it also really addresses one. It potentially makes these Chinese companies more profitable, which is great for us as investors. But it also addresses a major issue of not only the U.S. but E.U. where this over capacity, over production has really weighed on kind of sentiment and really it's created deflation in China. So some potential positives there.

A Fundamentally Different Approach to AI Development

Nadig: Got it. And as we think about this as, you know, sort of U.S.-based tech investors, obviously the story here has just been AI CapEx, AI CapEx seems to be keeping the entire market afloat. That's a different story in China, right? A lot of these companies are part of your portfolios. Talk to us a little bit about what I think we get wrong about AI when it comes to China.

Ahern: I think one is just on speaking of the solar is if you want to view this as a race and I don't personally believe in that narrative that this is some sort of a high race. But if that's the case, electricity is gonna be really really critical to that race, you know. And if that's the lens you want to look at it then China's won because 50 % of their electricity comes from renewables so it comes from hydro solar wind and nuclear, and so they're much, much further on. Their electricity costs are much lower.

So arguably, they're able to implement AI because they're not constrained by this antiquated electrical grid. They're not constrained by the lack of renewables here in the U.S. or lack of creating new nuclear plants. But yeah, definitely the leaders in AI and AI in China, it's all open source. Here in the US, we're building moats around, the companies are trying to build a moat around their business. In China, it's a very different strategy. Time will tell which plays out, but certainly the real beneficiary in AI has been the cloud computing. That's really Alibaba, Tencent, as well as Baidu.

And so we really see a very different way they're trying to AI, they want to implement it into the corporate world much, much faster, much cheaper, lower barriers to entry. So the net winner is going to be the cloud computing companies.

Nadig: Got it. So it sounds almost like loss leading your operating system. I remember we used to pay 400 bucks for a new copy of windows every year or two. And now it's just sort of now you're getting, you're, you're getting that along for the ride. You're sort of paying for office 365. It sounds like that's kind of been the model for AI in China where a company like Tencent or Alibaba who have huge both business and retail businesses throughout their stack, are effectively giving away what we're charging 20 to 200 bucks a month for here, is that right?

Ahern: They're giving it away. They're also basically incorporating it into their business model to really make that, in the case of say an Alibaba, that e-commerce experience more effective. In the case of Tencent, which owns WeChat, the kind of Facebook of China, they're really implementing that AI to get you to your interests much faster. So it is a different business model. And listen, these two systems can operate very independent of one another. Maybe those revenue models, we'll see how that plays out.

International Differences in China Sentiment

Nadig: Yeah, interesting. It'll be interesting to see how it evolves because, I mean, we all saw what happened when DeepSeek dropped an English language version. And all of a sudden everybody was like, wait a minute, this is free. How long can these moats survive? I think that'll be interesting.

Let's wrap up and talk a little bit just about the, like the sort of the institutional environment here for investing in China. A lot of us institutions pulled back over the last really five to 10 years. There was a lot of pullback in those big allocations. Some of that was around geopolitical concerns. Some of it was around either environmental concerns or human rights concerns and, you know, perfectly valid reasons people can have.

But now we seem to be facing something, a bit of a shift where it seems like Europe and the rest of the institutional market is going back into China in a pretty big way. Has the U.S. been there too or U.S. institutions still really cautious?

Ahern: Yeah, it's interesting, Dave, European listed China ETFs have about $8 billion of inflow year to date. Now, the European ETF market is about $3 trillion. US China ETFs have about $1.5 billion of net inflow, but our ETF market is $13 trillion. So we're seeing this re-rating certainly coming from non-US investors. I think some of that is a little bit of a rebalancing in Europe because of really the dollar's decline that it's really weighed on if you're a Swiss franc or euro denominated investor in the US. It's a real headwind.

I think for, in Asia, in the commodity world, the source of China information is not the Wall Street Journal or the Financial Times. That's really the largest companies in those countries. Like in Australia, the largest company is BHP. What does BHP say about China every quarter? It says it's the most important client, that Valet in Brazil, SQM in Chile, Southern Copper in Peru, Glencore in Switzerland. It's not the biggest company, but it's a big one. And so a lot of people get their China news not from Western media, they get it from listening to these quarterly CEO calls and they would tell you something's happening in China, that this doom and gloom is not necessarily true.

So I just think there's a lot of scar tissue around China. The China bulls like myself and our company, we're the ones that got hurt by the downdraft, some of these policy errors. And so I think that makes me constructive on the rally, a slow grind higher, but I think the main impediment has been the geopolitical for U.S. investors.

President Trump announcing that he's going to go to China in April, that's a huge signal that the Trump administration is trying to rebuild these ties with China diplomatically. And I think that'll allow U.S. institutions to come back into the space.

Talking Taiwan and Risk 

Nadig: Well, I don't want to be negative on this because I'm actually – I think this is a pretty strong bull case. Certainly you can look at metrics like patent filings or number of pharmaceuticals and trials and all of a sudden China is like a third of the world on all of those things fairly quickly. So I get the almost the raw tech play. I do want to mention the very real geopolitical risk side of this to Taiwan obviously is the thing you can't not talk about when you talk about China.

If we're looking out over the next year or two, which I think is about as long as you can look at anything right now, given the political environment, you know, we've got a potential trip coming in April, that's five or six months away. Do you feel like we've got a lid on the, you know, the South China Sea and Taiwan issues for the next year or two? Or do you think that that's gonna stay a hot topic?

Ahern: Yeah, I mean, it's obviously a complicated issue. A lot of history there and, you know, the events leading up to World War II. But ultimately, if I told you an event hadn't happened 27,740 times, which is, you'd say it's probably not very likely, but if I tell you that's the number of days that, since China's not invaded Taiwan since 1949…

Nadig: Tomorrow's pretty likely.

 Ahern: You'd say, “Well, the probability is much much higher right versus zero”. And so I think one; you know the TSMC fabs are the incredible life insurance policy, so to speak, that the whole world needs those fabs. That's not replicable anyplace else in the world. But also the Chinese government, they really do value stability and I think that those are strong arguments against a military invasion.

If that, let's be real, if the worst case scenario plays out, your biggest problem is probably U.S. equities, because what's Apple worth without China or Tesla or Exxon Mobil? Every US multinational is highly geared to China. It is the second largest economy in the world.

Nadig: Yeah.

Ahern: That's where ultimately we believe this initiation by the Trump administration, that's a good thing for all investors, whether or not you want to invest in China. A more stable world, the two largest economies getting along better with one another, that's a real net positive.

Nadig: Yeah, nobody wants a hot war. That's for damn sure. Well, Brendan, thank you so much. This has been incredibly helpful, incredibly insightful. I'm sure we'll get you back soon.

Ahern: My pleasure, Dave. Thank you.

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