BZ - CWEB: Extreme Bullish Performance Likely To Continue

Summary

• CWEB is a leveraged fund for Chinese Internet public companies. Its non-leveraged counterpart is KWEB.
• KWEB invests in internet commerce, information technology, and software applications companies.
• KWEB and CWEB have had a stellar performance since the bear market bottom on 24 October 2022.
• Both KWEB and CWEB are expected to continue their recovery. They are still extremely cheap.

Investment Thesis

KWEB and CWEB returned 96.36% and 245.09% in 65 trading days between 10/24/2022 and 1/26/2023. The chart below shows that these formidable returns have been made without any significant sell-offs.

My expectation is that this recovery is persistent and may continue, on and off with modest corrections for at least half a year. Therefore, I rate both funds as BUY. The choice between KWEB and CWEB depends mostly on the risk tolerance of the investor, those with low risk tolerance should invest in the non-leveraged, KWEB, fund, while the more aggressive may go with CWEB. Everyone is supposed to use strong risk management strategies because these funds are very volatile.

To appreciate the risks involved, one may look at the next chart, showing a very long downtrend of almost two years, from 2/22/2021 to 10/24/2022. During this interval KWEB and CWEB returned -79.33% and -97.78%, respectively. To recover from these devastating losses, KWEB would need a gain of 484%, while CWEB needs 4,504%.

Although enormous, those figures should not scare the investors experienced in the way markets work. If anything, we all read the mantra that “leverage” is dangerous and leverage funds are only day-trading instruments, suitable only for hedge funds specialists and professional traders. This is a myth that gets demolished by a simple argument.

Both graphs show that the consistency and strength of the trends presented outstanding opportunities for long term trade. A long CWEB trade initiated on 10/24/2022 would have gained 245%. That is more than twice the 96% return of KWEB. This is a nice example of the fact that in steady uptrends the leveraged funds compound additional gains, above the leverage factor.

A similar argument can be made for downtrends, but I will not dwell on it, since this article is addressed to long-only investors. The hedge funds specialists know quite well how to profit by shorting the markets.

KWEB Fund Data

Inception Date: 7/31/2013

Net Assets: 6.5 B

Yield: 0.44%

Expense Ratio: 0.69%

Top 10 Holdings as of 2023-1-25

Tencent Holdings Ltd 10.88%

Alibaba Group Holding Ltd Ordinary Shares 9.75%

Meituan Class B 7.23%

JD.com Inc Ordinary Shares - Class A 5.98%

Pinduoduo Inc ADR 5.80%

NetEase Inc Ordinary Shares 4.43%

Tencent Music Entertainment Group ADR 4.09%

Kanzhun Ltd ADR 4.00%

Trip.com Group Ltd 3.96%

KE Holdings Inc ADR 3.93%

# of Holdings 34 as of 2023-01-25

KWEB Valuation

All the stocks in KWEB have low valuations. The weighted average of the price to book, sales and cash flows are considerable lower than those of the similar US stocks.

Price/Book = 4.29

Price/Sales = 0.55

Price/Cash Flow = 23.65

Technical Analysis

The weekly price charts of KWEB and CWEB are identical twins. The top was in February 2021 and the bottom in October 2022.

The KWEB chart shows a “bullish” cross of the 10-week with 40-week MA sometime in the last week of December. The same pattern happened about two weeks later on CWEB.

Both charts indicate a strong uptrend, which I believe is likely to continue.

Next is a “relative rotation graph” of KWEB, CWEB and TCEHY, BIDU. It illustrates the fact that the outperformance of Chinese internet stocks is in full swing and has a strong momentum.

Both funds have options. KWEB has LEAP options two years out, to January 2025. CWEB options market is very limited with the longest expiration in six months, by July 2023.

Cautionary Notes

These notes address the extra risks associated with trading of leveraged assets, such as CWEB.

First, here it is a statement by FINRA about trading in inverse and leveraged funds.

“ Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets. ”

Regulatory Notice 09-31 | FINRA.org

The following chart illustrates the value erosion suffered when a leveraged fund is held for a long time period. While KWEB returned 6.54% in the last twelve months, the 2X leveraged fund CWEB returned -32.57%, a significant loss.

Conclusion

Ratings for CWEB and KWEB are BUY.

Both funds are very volatile and require strong risk protection measures.

As a leveraged fund, CWEB is NOT suitable as long-term investment and is recommended as BUY only for short-term tactical investment. Long-term investors should use the non-leveraged KWEB fund.

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