KBA: Still A Compelling Play On China’s Market Revival

The key Asian outperformer has been China, where investor sentiment seems to have finally turned, particularly for mainland listings (i.e., A-shares), since my last call on KraneShares’ Bosera MSCI China A 50 Connect Index ETF (NYSEARCA:KBA) (see KBA: Poised To Benefit From A Chinese Dragon Year Turnaround). Fundamentally, there hasn’t been much earnings support for the move, nor have property prospects improved. Yet, China’s trough-level valuation (historically and relative to global peers) appears to have been more than enough to drive its resilience through a period of global uncertainty.

Policy support has also been key, with a pro-growth tone at last month’s Politburo meeting coming on the heels of market-friendly measures like a Japan-inspired corporate governance reform effort, as well as a stock market ‘rescue’ package by state-backed funds. To fully capture the China rebound, onshore narrower large-cap ETFs like KBA continue to rank highly, in my view. From here, ongoing policy easing (likely at the ‘Third Plenum’ in July) and Q1 2024 results (against relatively low market expectations) will be critical to supporting the next leg of China’s rally.

KBA Overview – A-Share Fund with an Intact Cost Advantage

The KraneShares Bosera MSCI China A 50 Connect Index ETF is a tracker fund specifically focused on the fifty largest and most liquid large-cap stocks listed in mainland China (i.e., A-shares). While KBA has suffered from persistent outflows in recent years, a combination of Chinese market outperformance and a slight improvement in investor sentiment has propelled its asset base higher this quarter.

On a relative basis, though, the fund size continues to trail more conventional A-share tracker funds like iShares MSCI China A ETF (CNYA) and X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) at $294m and $1.8bn, respectively. Where the fund does stand out, on the other hand, is fees, as its intact 0.55% net expense ratio remains industry-leading – CNYA charges 0.6%, and ASHR charges 0.65% by comparison.

The catch is that KBA’s fee waiver, worth ~13bps, runs out in August this year; without an extension, investors could end up with a higher 0.78% gross expense ratio instead. Bid/ask spreads are also fairly tight at 5bps (only ~1bps above larger peers CNYA and ASHR), so for now, KBA continues to rank highly on overall cost.

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Sources: KraneShares, iShares, Xtrackers

KBA Portfolio – A Narrower but Well-Balanced Mix of Large-Caps

Per KBA’s April 2024 factsheet, its portfolio retains one of the more well-balanced sector breakdowns within the A-share ETF universe. The Financials sector remains, like other A-share funds, the largest exposure at a broadly unchanged 19.1%. The rest of the portfolio has seen some reshuffling, though, with Consumer Staples losing the most share (down to 13.0%) in favor of Industrials and Information Technology (both up to 14.7%). Materials (up to 11.7%) is the other >10% sector exposure.

The single-stock portfolio has also been reshuffled somewhat, with battery producer Contemporary Amperex Technology now the largest holding at 7.1% after a strong year-to-date rally. Liquor company Kweichow Moutai has also appreciated this year, albeit at a much slower pace; hence, its comparatively lower portfolio share at 6.5%. Two other Materials names, Zijin Mining (6.0%) and Wanhua Chemical (5.4%), are notable gainers, while electric vehicle company BYD (OTCPK:BYDDY) continues to lose share amid an ongoing industry-wide price war. Comparable A-share ETFs like CNYA and ASHR share similar top-ten holdings, albeit with more bank stocks and much smaller single-stock % allocations (by virtue of their different portfolio sizes).

KBA Performance – Light Emerging After a Multi-Year Capitulation

Investing in Chinese equities has been a painful experience for many years now, as evidenced by KBA’s track record. Through a COVID-impacted one and three-year period, for instance, KBA delivered annualized declines of -10.6% and -12.5%, respectively. While performance improves the further you zoom out, the annualized five (-0.4%) and ten-year (+4.5%) total returns haven’t been all that spectacular either.

More recently, however, China has seen a revival in fortunes post-New Year, as a very strong three-month return for KBA shows. By comparison, ASHR and CNYA have both lagged on the way up, highlighting the benefits of KBA’s portfolio sizing approach. So, while the relatively more defensive, higher-yielding equity portfolios of ASHR and CNYA have been the way to go through a multi-year China bear market, the inverse may be true if we do see a sustained bull market this year. KBA’s narrow tracking error, a result of the fund tracking more liquid stocks with better hedging options, is another plus.

Still a Compelling Play on China’s Market Revival

China has stood out for its valuation discount to global equities for a while now; thus, it’s perhaps not so surprising that the likes of KBA have outperformed recently. The key question from here is whether this rally can be sustained? Given China remains as cheap as it’s ever been on forward numbers and with market-friendly policy support ramping up, I think it still makes a lot of sense to stay engaged here. After all, there remains plenty in the pipeline, including future policy easing and increased capital returns, both of which would see stocks inflect higher. As recent months have shown, more concentration works better in a bull market; in this context, KBA continues to screen attractively within the A-share ETF universe.