KBA ETF: Running a long-term recovery with 13x earnings

KraneShares Bosera MSCI China A 50 Connect Index ETF (NYSEARCA:KBA) tracks the MSCI China A 50 Connect Index. The China A 50 Connect Index consists of the 50 largest participating companies in China. For starters, China A shares Shares of Chinese companies traded on the Shanghai and Shenzhen stock exchanges. By investing in KBA, investors can gain diversified exposure to some of the largest and most liquid Chinese companies. The fund was established in 2014, and at the time of writing had approximately $203 million in assets.

3 pillars of China’s stock market problems

Investors who pay attention to international markets are well aware that Chinese stock markets have faced significant headwinds, both in terms of underperformance and volatility, over the past few years. They are generally attributed to the following:

1.) China’s zero-sum policy on coronavirus: China It had one of the world’s strictest coronavirus policies. The long tail of this very strict lockdown continues to impact Chinese businesses and consumers.

2.) Real estate market crisis: The collapse of Evergrande in 2020 led to crackdowns on excessive borrowing to help curb developers’ debt burdens. This has been a hindrance to the real estate sector which has been booming in the country ever since.

3.) Increased geopolitical tensions: Investor sentiment was affected by China’s escalating geopolitical tensions with both the United States and Taiwan. These tensions are being accelerated by the global race to shore up AI supply chains, as well as China’s growing military presence around the island of Taiwan.

Well diversified across sectors and properties

This is a well-diversified sector fund, with the top allocations going to financials, industrials, technology and consumer defenses. The fund’s smallest allocations go to energy, telecommunications and real estate. KBA uses a sector balancing methodology.

At the individual holding level, we see a similar diversification story. The 10 largest holdings make up about 47% of the fund’s total assets. The largest allocation goes to liquor distributor Kweichow Moutai Co, known for its popular Chinese alcohol brand Baijiu. While Kweichow has a 5-year total return of ~88%, it returned -1.6% on a single annual basis. The next biggest spot goes to Contemporary Amperex Technology, a lithium-ion battery manufacturer, down 10.7% year over year.

Flows did not recover in 2024

KBA suffered from inflows in the previous five-year period. Slow flows I was afflicted Many Chinese funds due to the above issues. However, the fund saw positive net flows in 2020 and 2022, despite the Covid-19 period. Year-to-date, the fund has already accumulated almost as many outflows as 2023. However, we are only five months into the year, and if there is a continued rally in Chinese stock markets, we could see this number dwindle.

Performance comparison

When comparing KBA with two similar A-share funds, CNYA and ASHR, we can see that all funds are in the red on a one-year trailing basis. However, KBA still outperforms its rival funds. This is likely due to KBA’s sector arbitrage methodology, which is a differentiation from other A-share funds.

From a risk perspective, KBA’s volatility is slightly high, while the other two funds are more in line with each other. All of these numbers are higher than standard emerging market expectations. The 30-day rolling volatility of the iShares MSCI Emerging Markets Fund is currently around 14%. This is in line with expectations given the challenges that have been unique to China during the recent period.

The dawn of the Chinese stock market, or is it a value trap?

Select sectors in China are starting to make a comeback in 2024, partly due to support from the Chinese government. However, it remains to be seen how long the optimism will last. The question I ask myself is whether or not the coronavirus has triggered a structural correction more than anything else in Chinese markets. China has long passed as the darling of the global demographic. India is now the most populous country in the world. The coronavirus has done long-term damage to investors’ psyches. However, it’s hard to overlook KBA’s positive valuation multiple. The current book value is 1.58 and the P/E ratio is 13.5x. Its yield is currently 2.17%. Regardless of whether foreign investors are more skeptical than ever, this fund is still heavy companies that will enjoy sustainable domestic demand.

Conclusion

KBA provides exposure to one of the largest global markets and has made great strides since the Chinese stock market slowdown that began in the immediate aftermath of the coronavirus. I struggled from a flows perspective. Recent crises have forced the government to take an appropriate inventory of the current business climate. I think a market decline could ultimately be a boon for investors, as efforts to strengthen corporate governance could push stocks even further. With the current valuation multiples and global positioning, I currently rate KBA as a Buy.