CWEB: Beat Up Internet Bull At Whim Of Chinese Administration

Summary

  • CWEB provides leveraged exposure to a swathe of Chinese Internet names.
  • Its synthetic make-up is comprised of information technology, software, IT services & application software.
  • The ETF is, to some degree, a leveraged version of the more widely known KWEB.
  • With China’s administration cracking down on the capitalist elite in an all-out continued power grab, this one is not for the faint of heart.
  • Country risk galore.

Introduction

China has taken an ax to prominent well-run, highly capitalized domestic companies. It is a perceived tightening of grip by the Chinese Communist Party, as it embeds itself more profoundly into society via real-time monitoring, digital surveillance, and social credit systems.

A possible gambit on Asian culture of not speaking out, challenging the status quo, or questioning illustrious leadership. George Orwell – eat your heart out.

The techno-authoritarian superpower, entangled in a Sino-American geo-political tug-of-war, continues to exert total control over every aspect of Chinese life – including its capital markets.

And proof is in the pudding – with an overabundance of bloodied Chinese equities getting beat-down more prominently than a UFC mixed martial arts bonanza.

All commenced with an increasingly hawkish Jack Ma openly mouthing-off about China’s arcane, er……advanced banking infrastructure. That bode poorly for China’s wealthiest businessman, who vanished from public spotlight, only to find his latest IPO-hit (ANT+) shelved, indefinitely. Coincidence most likely. Since then, the tech magnate behind other hit titles such as Alibaba (BABA), has seen his appeal plummet just as notably as the companies he owns.

China’s plethora of Cayman-islands based, US listed, tuition mainstays were next in line. Organizations such as TAL Education (TAL) and New Oriental Education & Technology (EDU), allegedly profiteering from Chinese parental investment in children, were stopped in their wake with regulation forcing them into not-for-profits. Equity values plummeted just as fast as shareholder value was egregiously destroyed.

Just recently we have seen other intriguing moves – such as a possible limitation of 3 hours maximum for Chinese gamers, a crackdown on China’s celebrity tax dodgers (Zheng Shuang was recently fined $46M), and laws surrounding censorship of economic data. Commander and Conquer, Red Alert may possibly be a video game now seeing less airtime on the mainland.

In any case, Adam Smith, with his invisible hand, would be rolling in his grave right about now. But its arguably the communist model which has thrust China into the economic powerhouse it is today, and not the capitalist one.

Reeling from the spate of haphazard power plays, for the everyday investor it remains challenging to make head nor tail of it. And this is the fundamental problem with Direxion Daily’s CSI China Internet Bull fund (CWEB).

With Chinese capital markets randomly shifting at every new regulatory move, it is virtually impossible to deploy funds without taking on gargantuan country risk. I have personally observed more predictable random walks than the current state of Chinese capital markets.

The positives are there – no, I am not speaking about SARS-Cov2 cases – but rather a burgeoning middle class, economic growth, and increasing national prosperity. But none of this makes endorsing a position in CWEB any easier.

This may specifically be for overly optimistic investors with a penchant for pain, mammoth country risk or simply a tumultuous ride. But for the rest of us, while not necessarily being shortable, capital may be better deployed elsewhere. Neutral.


Source: Market Chameleon

Product Synopsis

Direxion Daily CSI China Internet Index Bull 2x shares (CWEB) provides China-centric thrill-seekers with 2x leveraged exposure to an index constituted mainly of overseas-listed Chinese technology outfits. The package is, at least to some extent, a rocket-fuel boosted proxy of KraneShares CSI China Internet ETF (KWEB) as the more well-known ETF is the mix to which leverage is applied to provide CWEB its boost. At least figuratively.

As per the fund prospectus, the target index – CSI Overseas China Internet Index – is engineered to measure the performance of publicly traded China-based ventures whose primary business is the internet or internet-related sectors. To qualify for the index, the following criteria needs to be satisfied:

The company is incorporated in mainland China
The company headquarters are in mainland China or
At least 50% of revenue from goods and services sold is derived in mainland China
Exclusions to the index include firms with daily average trading values sub $500K or daily average market capitalizations of less than $500M. Consequently, the index is a representation of large-cap, China centric technology firms with a focus on the digital economy.

Year-to-date total returns CWEB v KWEB

Source: Trading view

Price action for CWEB has been beat down with the fund haemorrhaging -56.30% year-to-date, logically outpacing its non-leveraged counterpart KWEB to the bottom (-28.44%). Neither funds’ returns have been worthy of starting your own Twitter feed, nor posting pictures of lambos.

Historical % price change YTD v holdings (KWEB)

Source: Koyfin

Because CWEB is arguably a leveraged version of KWEB, a deeper look into the latter’s scatter diagram of returns v weightings paints a comparably miserable picture, with a large part of holdings deep underwater. The leader board of laggards provides a grim outlook with the decimated tuition stocks leading the pack.

TAL Education group with its tiny weighting of 0.63% is among the biggest negative returns recidivists, with the stock losing -91.99% YTD, the equivalent of a -561-bps lead weight on KWEB returns. For our ETF, CWEB you need to approximately amplify this 2x.

Other laggards include Pinduoduo with 7.73% of KWEB’s weighting for a -39.36% negative return (-389 bps to KWEB returns), KE Holdings 2.23% weighting for -64.25% YTD returns (-311 bps) and Alibaba 8.91% weighting for -24.74% YTD returns (-227 bps).

Key ETF laggards for KWEB – the unlevered proxy of CWEB

While it is important to emphasize that these returns are for KWEB and not our ETF CWEB, the dismal panorama points to more top hits that House of Pain’s Shamrock & Shenanigans. In any case, our ETF CWEB would be impacted by these returns given KWEB’s generous representation in the fund make-up.

Product Structure

Top Holdings (CWEB)

Source: Etfdb.com

That fund composition can be amply observed here – with KWEB making up around ~64% of the ETF in addition to some $USD and a range of other securities providing leverage effect. Delving into individual fund contributors without researching the unlevered version KWEB provides little insight into the individual stocks dragging the most on the ETF.

Analysis of individual fund contributors to CWEB is tricky as it figurative is a replication of KWEB on steroids

Source: Koyfin

Numerous sectors contribute to (our closest proxy) KWEB’s negative returns – consumer discretionary (-41.39%), communication services (-18.33%) and information technology (-26.36%) head up dreary casting line-up. Of that, interactive & direct marketing retail (-30.50%), interactive media services (-9.52%), and entertainment make up the lion’s share of the losses (-29.78%)

Sector & Industry Breakdown (KWEB)

Source: Koyfin

A deeper look into the fund structure somewhat adds insult to injury. With among the loftiest expense ratios, even for more leveraged exotic plays, investors must ponder if they are truly getting bang for their buck?

Agreed – leveraged more atypical ETFs normally attract sizable fees linked to administering derivative trades so critical to the fund’s artificial lift. But questions must be asked whether despite -50% negative returns on an unpredictable ETF with boatloads of country risk coupled with notable counter party risk really merits 1.30% per year to the manager. Somebody is making money out of this – possibly not the investors.

No real other notable standouts come to the fore – the 5-year-old package has attracted $265M in assets under management and turns over around $17M daily. Logically, this is much less than KraneShares KWEB – with its $7B in money managed & $624M daily churn – given that leveraged ETFs are more widely used for punctual trading set-ups rather than long-term plays.

Comparative analysis CWEB v KWEB

Source: Spreadsheet developed by author with inputs from ETF.com, Etfdb.com and Koyfin

An options market for both packages exist, possibly to protect whatever capital you have left, but volatility is remarkably high given the turbulent path the fund has traced. This makes any form of insurance via the purchase of put options excessively expensive, not unlike the management fees.

Seasonal volatility by day of year (CWEB)

Source: Market Chameleon

Key Takeaways

  • China focused equities, oft listed in the United States, have been obliterated as a range of government measures aimed at tightening control over power dampen investor sentiment.
  • Such measures have created a degree of unpredictability rarely seen in global capital markets – it appears that any sector can be targeted at any time, catapulting country-risk perchance to highs never seen before.
  • Subsequently, questions surround whether equity risk premiums fully reflect risks run by money management thrill seekers intent on enjoying a roller coaster ride.
  • CWEB is one of many China-focused ETFs – with this one providing 2X daily leveraged returns on CSI Overseas China Internet Index. Daily is a key word here as compounded returns and path dependence often imply long-term divergence from a fund’s benchmark.
  • Price action for the fund year-to-date has been bleak to say the least with previously mentioned country risk and unpredictable capital market regulations.
  • CWEB is comprised of KWEB (a non-levered China Internet ETF) coupled with OTC derivative instruments geared to give the fund its artificial lift. Accordingly, a deeper look into KWEB provides tell-tale clues as to who the culprits are in this all-out lag-fest.
  • The fund has managed to accumulate $265M over its ~5 years of existence.
  • Expense fees (+1.30%) are among the highest I have observed for ETFs – even more onerous, colorful ones like leveraged thematic plays.

For many years now, I recall the China investment narrative hard-sell. With pundits, money managers and gurus all touting the resilience and opportunity behind one of the world’s greatest economies.

But things have since changed – a range of stock blow-ups, scandals surrounding Chinese firms raising capital in the US to defraud foreign investors (see the China Hustle), and escalating tension have pushed country risk, and not risk adjusted returns, to the moon.

While buy the dippers and bargain hunters may premise long-term upside, it’s hard to put the same time-tested “In Fed we trust” slogan on an unpredictable foreign administration.

Most likely this post will age poorly as money returns to ETFs like CWEB, consequently pushing it to the upside. But it remains excessively challenging to endorse an ETF which, among all typical risks we see in securities trading, comes checkered with monumental geo-political impulsiveness.

Author: ZMK Capital, Seeking Alpha

You might also like