Investing in China’s innovation surge

Key points:

• China is shifting from factory to innovator: China is actively transforming from a low-cost manufacturing hub to a global innovation powerhouse, with a top-down push into AI, semiconductors, green tech, and biotech — backed by massive capital, talent, and policy support.
• Investment opportunities are sector-specific: Innovation leadership is emerging in select areas like EVs, digital health, and AI-powered platforms. Strategic domestic champions (e.g. BYD, SMIC, Alibaba Health) offer asymmetric opportunities due to attractive valuations — despite geopolitical and regulatory risks.
• Portfolios can benefit from selective China exposure: For investors willing to navigate volatility, Chinese innovation assets can diversify US tech-heavy portfolios, especially given lower valuations, rising sector independence, and a maturing domestic funding ecosystem.

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After years of being seen mainly as the world's factory, China is now setting its sights on a new identity: a global innovation powerhouse.

While geopolitical tensions and domestic challenges persist, ignoring China’s innovation push could mean missing out on major shifts across sectors and markets.

For investors, understanding this transition — away from a stimulus-driven growth model to innovation leadership — is essential.

What is changing?

National AI acceleration via DeepSeek

The meteoric rise of DeepSeek — a government-backed AI model developer — underscores China’s commitment to democratizing artificial intelligence. Since its public debut in January, DeepSeek’s large language models have been rapidly adopted by major Chinese corporates and AI platforms. This reflects a broader, centrally coordinated push to embed AI capabilities across industries. DeepSeek’s cost-efficient, plug-and-play architecture enables smaller firms and developers to integrate advanced AI easily, potentially driving an explosion in AI-powered apps and productivity tools across China’s digital economy.

Government-led push

US export controls and technology restrictions have inadvertently accelerated China’s efforts toward independence in semiconductors, AI, and quantum computing, pushing local champions to innovate faster. China’s 2025 policy agenda places technological innovation at the center, with major increases in funding and support for high-tech industries such as AI, quantum technologies, semiconductors, and green innovation.

The government is allocating substantial resources, including a trillion-yuan tech fund and billions in special bonds, to boost R&D, upgrade equipment, and modernize manufacturing. China aims to build a “digital China” by 2025, targeting breakthroughs in digital infrastructure, digital economy growth, and innovation in digital technologies across sectors like manufacturing, healthcare, and energy.

New Quality Productive Forces (NQPFs)-a model emphasizing rapid scientific and technological innovation-are now a core pillar of China’s growth strategy, with a focus on integrating digital technologies into traditional industries and fostering emerging sectors.

Capital commitment

Despite global capital outflows, domestic venture capital and state-driven funding are accelerating investment in strategic industries, particularly in semiconductors, AI, and biotech.

China has allocated over $300 billion initially and an additional $1.4 trillion post-COVID to boost R&D in sectors like semiconductors, AI, and green energy. A dedicated 1 trillion yuan ($161 billion) fund targets semiconductor self-sufficiency. High-tech firms also receive subsidies, tax incentives, and government-backed financing to reduce production costs and accelerate innovation.

Talent and scale

With the largest STEM graduate pipeline in the world, China is building a self-sustaining innovation ecosystem that can support continuous technological advancement.  

Where is China’s innovation gaining ground?

Semiconductors

Despite US export restrictions, China’s efforts in chip design (if not yet fabrication) could reshape global supply chains over time.

• SMIC (0981.HK): Progressing toward 5nm chip production despite sanctions, with $7.5 billion annual capex aimed at capacity expansion.
• Hua Hong Semiconductor (1347.HK): Focused on mature-node chips critical for automotive and industrial IoT, supported by a $2.6 billion STAR Market listing.

Electric vehicles (EVs) and batteries

China already dominates global battery production. Innovations in solid-state batteries and EV affordability could reshape the global auto industry.

• BYD (1211.HK): The world's largest EV maker, combining affordable models with in-house battery innovation. Targeting 800,000 exports in 2025 and expanding aggressively across Europe, Asia, and Latin America.
• XPeng (XPEV /9868.HK): Focused on autonomous driving leadership, XPeng recently launched its XNGP system, a serious contender to Tesla’s FSD.
• Horizon Robotics (9660.HK): Specializes in edge AI chips and autonomous driving computing platforms. It develops AI processors (like the Journey series) optimized for smart vehicles — processing perception, decision-making, and autonomous driving tasks inside the vehicle without needing constant cloud connection.

Smart devices and consumer electronics

• Xiaomi (1810.HK): Launching its first EV, the SU7, to diversify beyond smartphones, alongside its massive smart home ecosystem expansion.
• Huawei (private): Despite sanctions, successfully launched 5G-capable smartphones and remains a frontrunner in 6G and smart car technologies. Huawei is also testing its new Ascend 910D chip, designed to excel Nvidia’s H100.

Other artificial intelligence (AI)-powered solutions

China is advancing in AI models, applications for manufacturing, finance, and smart cities — even if still catching up to the US in foundational models.

• Alibaba Group (BABA /9988.HK): Through Alibaba Cloud, it leads China's enterprise-focused AI development, including proprietary large language models.
• Tencent Holdings (0700.HK): Deploying AI across gaming, cloud, and social platforms to deepen user engagement and operational efficiency.
• NetEase (9999.HK): Leveraging AI in next-generation gaming, positioning itself as a challenger to international gaming majors.

Biotech & specialty pharma

China is investing heavily in genomics, personalized medicine, and biotech startups — aiming to reduce dependency on Western pharma.

• WuXi Biologics (2269.HK): A global leader in biologics manufacturing, recently introducing Green CRDMO to reduce carbon footprints in biologics production.
• Innovent Biologics (1801.HK): Approved new targeted therapies such as Limertinib for lung cancer, strengthening its oncology pipeline.
• Hansoh Pharmaceutical (3692.HK): Signed a licensing deal with Merck for its obesity drug HS-10535, reinforcing its innovation credibility globally.

Digital health & AI-powered healthcare platforms

China’s healthcare sector is undergoing rapid digital transformation, driven by the convergence of AI, telemedicine, and policy support for tech-enabled health services. The recent surge in healthcare stocks following the release of Alibaba’s new Qwen3 AI model underscores investor enthusiasm for the sector’s next phase of growth.

The adoption of generative AI in digital health platforms is expected to expand access, streamline diagnostics, and enhance patient engagement — especially in an ageing society with growing chronic disease burdens.

• Alibaba Health (0241.HK): A leader in China’s online pharmacy and digital consultation space. Alibaba’s launch of the Qwen3 AI model is expected to power new diagnostic and service capabilities across its platform.
• JD Health (6618.HK): China’s largest online healthcare platform by revenue. JD Health continues to expand its AI-based medical assistant offerings and has deep integration with JD’s e-commerce and logistics networks.
• Ping An Healthcare and Technology (1833.HK): A key player in telehealth and smart health management, Ping An’s Doctor app is supported by one of the country’s most advanced AI triage systems.
• Yidu Tech (2158.HK): Focused on AI-based healthcare data solutions, Yidu Tech provides hospitals and pharmaceutical companies with analytics tools for clinical research and real-world evidence generation.

Green tech and renewables

China leads the world in solar, wind, and green hydrogen technologies. Innovation in energy storage and grid tech could upend traditional energy dynamics. Beyond clean energy manufacturing, China’s mining champions are securing the raw materials critical for the global electrification and decarbonization drive.

• Xinyi Energy Holdings (3868.HK): A leading operator of solar farm assets in China and Southeast Asia. Xinyi Energy focuses on acquiring, operating, and managing utility-scale solar farms, ensuring stable cash flows and contributing directly to China's renewable power generation targets. Its expansion strategy is closely tied to Beijing’s 2030 carbon neutrality ambitions.
• Zijin Mining Group (2899.HK): One of China’s largest and most diversified mining companies, Zijin is aggressively expanding into lithium and copper — key enablers for battery and renewable energy industries. Recent acquisitions and project expansions position Zijin as a global resource powerhouse.
• Zhaojin Mining Industry (1818.HK): A leading gold and precious metals producer, Zhaojin is investing in green mining technologies and expanding its resource base to align with rising industrial and investment demand for metals critical to energy transition themes.
• Lingbao Gold Group (3330.HK): Focused on gold, copper, and other base metals, Lingbao Gold is modernizing operations to improve environmental sustainability. It plays a role in securing China’s upstream resource supply for both industrial use and renewable infrastructure.

How investors should approach this shift

• Recognizing the innovation shift: China’s transition from a manufacturing-led economy to an innovation-driven one is advancing rapidly. However, success will be sector-specific, with leadership likely concentrated in industries aligned with domestic policy priorities such as green technology, healthcare innovation, and digital transformation.
• Threats to US tech dominance: Chinese innovation could chip away at US dominance in sectors like EVs (Tesla vs. BYD), solar (First Solar vs. LONGi), and biotech. <expand here>
• Capitalizing on attractive valuations: Many leading Chinese innovators currently trade at a significant discount relative to their US and European counterparts. Forward earnings multiples for Chinese tech and healthcare companies are often half those of similar Western firms, creating an asymmetric opportunity for investors willing to navigate the risks.
• Diversifying beyond US tech: Adding selective China exposure can meaningfully diversify portfolios that are heavily tilted toward US mega-cap technology. Correlation between Chinese equity markets and US indices has declined, making China an increasingly attractive diversifier in global portfolios.
• Managing geopolitical and regulatory risks: Investors should consider prioritizing domestic champions whose business models are less dependent on global supply chains or Western markets. Exposure should be sized appropriately, with an emphasis on companies aligned with China’s long-term strategic goals.

Risks to monitor

• Geopolitical tensions: Relations between China and the US, as well as China and Europe, remain strained. Potential sanctions, tariffs, or restrictions could introduce unexpected volatility and disrupt sector growth trajectories.
• Regulatory shifts: Chinese authorities have a history of intervening in key industries, sometimes abruptly. Investors must monitor the regulatory landscape closely, particularly in sectors such as technology, healthcare, and education.
• Profitability pressures: Rising government involvement presents challenges to profit maximization. Public sector tends to favor fixed-price contracts, and companies aligned with national digital goals may be expected to accept projects at lower margins.
• Corporate governance and transparency: While improvements have been made, governance standards in some Chinese companies still lag behind Western peers. Prioritizing companies with strong disclosure practices, reputable auditors, and international listings can help mitigate some of these concerns.
• Economic growth uncertainty: China's broader economy faces challenges, including property sector stress, high youth unemployment, and subdued consumer sentiment. Although innovation sectors are more insulated, broader economic pressures could affect sentiment and capital flows.
• Liquidity constraints: Certain Hong Kong and Mainland China-listed securities may exhibit lower liquidity compared to US equities. This could complicate entry and exit strategies during periods of heightened market stress.