2023-06-25 23:26:42 ET
Summary
- China's economy has not experienced the expected boom after the lifting of COVID-19 restrictions, leading Goldman Sachs to lower its 2023 GDP growth forecast.
- The KraneShares China Internet and Covered Call Strategy ETF offers an attractive current yield given neutral and volatile KWEB price action.
- I expect KLIP's buy-write strategy to outperform KWEB over the coming months, but investors should understand the risks.
What went wrong with the China re-opening story? The consensus thinking was that the government’s strict zero-COVID policy lifting would usher in a spending and activity boom in the world’s second-largest economy. That has not played out, at least not to the extent that so many emerging markets bulls were hoping. That reality was cemented last week when Goldman Sachs lowered its 2023 GDP growth forecast amid ongoing real estate and export market softness.
One of the stock market's spots has been particularly weak and volatile. China’s tech sector, as measured by the KraneShares CSI China Internet ETF (KWEB), got off to a hot start this year, rising 20% through late January, but is down more than 11% on the year after a rough last 5 months. There is now a new ETF that aims to capture high volatility through call selling.
I have a buy rating on KraneShares China Internet and Covered Call Strategy ETF (KLIP).
China Growth Prospects Sagging
According to the issuer , KLIP follows a “covered call” or “buy-write” strategy. KLIP buys shares of the KWEB and “writes” or “sells” corresponding call options on KWEB. Both KLIP and KWEB are benchmarked to the CSI Overseas China Internet Index, which tracks the performance of the investable universe of publicly traded China-based companies in the Internet sector. KLIP can provide investors with an attractive current yield while retaining capped participation in the potential price gains of KWEB.
KLIP’s portfolio is 100% invested in KWEB and it has a 2% cash position via its short-call positions. The ETF has a high 0.95% annual expense ratio and holds more than $25 million in assets under management as of June 22, 2023.
For background, a covered call ETF is a fund that provides investors with premium income by writing options on stocks or ETFs. Covered call ETFs manage the options exposure for investors, which can be more economical and time efficient than buying individual stock options. Writing covered calls may produce higher yields during periods of market volatility, according to KraneShares.
KLIP: Monthly Distributions So Far This Year
KraneShares
What makes the fund appealing right now is that KWEB implied volatility continues to run high. Notice in the charts below that KWEB features a higher “IV” compared to other US market indexes, that offers investors a much higher current income yield when selling option premium. The risk, though, is seen when KWEB rallies sharply, leading to the calls KLIP’s strategy sells turning in the money – that essentially caps potential gains on KLIP. Still, given lower price trends during the first half of the year, KLIP sports impressive alpha compared to KWEB.
KWEB: Very High Volatility, Richly-Priced Options To Be Sold
Since its January inception, KLIP is down just 2%, better KWEB’s total return by some 20 percentage points.
KLIP Down Modestly Since Inception
Digging into the KWEB portfolio (which KLIP owns), it is primarily a large-cap growth fund. Even with that factor outperforming in the US this year, that relative strength has not translated into gains for China’s tech giants. With a price-to-earnings ratio of just under 18 and robust long-term earnings growth, the PEG is barely above 1, indicating a solid GARP value play. KLIP adds a spice to KWEB in that the latter’s yield is exceptionally low whereas the former’s yield of 21.5% is massive.
KWEB: A Large-Cap Growth Portfolio
But is now an ideal time to own KLIP? This is always a nuanced decision with a covered call ETF. It depends on your benchmark. If we are comparing KLIP to KWEB, seasonal trends suggest more downside ahead, implying that owning KLIP is the more favorable move. According to data from Equity Clock , KWEB tends to suffer in Q3.
Bearish KWEB Price Trends Seen In Q3, On Average
The Technical Take: KLIP & KWEB
For KLIP itself, technical analysis is particularly less useful right now considering its limited price history and its high yield. Recall earlier that the fund is down just 2% on a total return basis since late January. The price-only chart, however, shows a pronounced downtrend. But what we can glean from the price graph is that volume is increasing. KLIP is evidently becoming an increasingly popular way to play China. Investors expecting more neutral to downside price trends in KWEB can look to KLIP for potential income gains.
KLIP: Volume Trending Higher
As far as KWEB is concerned, I see the continued “no trend” theme playing out. Notice in the 3-year view below that the ETF has a flat 200-day moving average and the ETF has done nothing for more than a year now. Until something shifts, selling call premium on this go-nowhere fund seems like a savvy play. I would switch out a long KLIP position in favor of a long KWEB position should KWEB break above its early 2023 high of $36 and change.
KWEB's Sideways Trend Benefits KLIP's Call-Selling Feature
The Bottom Line
While I like the valuation of KWEB considering its growth outlook, neutral price action amid high volatility makes selling calls a compelling idea. Thus, I have a buy rating on the KLIP China tech buy-write portfolio.
For further details see:
KLIP: Selling Expensive KWEB Options Is An Appealing Strategy