RBC’s autocalls on KraneShares CSI China: straight from the value playbook, contrarian says

By Emma Trincal

New York, Feb. 18 – Royal Bank of Canada’s 0% autocallable notes with contingent downside due Feb. 18, 2025 linked to the KraneShares CSI China Internet ETF combine the right underlying with a structure that may appeal to value investors, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the ETF closes at or above its initial level on any annual call date, the notes will be automatically called at par plus a call premium of 18% per year, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called and the ETF finishes at or above its 70% barrier level, the payout at maturity will be par. Otherwise, investors will lose 1% for each 1% decline of the ETF from its initial level.

Margin of safety

“I like it because it’s a very undervalued fund,” said Kaplan.

“You’re likely to be above 100 any of these years and most likely a year from now.”

On the trade date, the KraneShares CSI China Internet ETF closed at $37.81.

“This ETF has significantly dropped in price from where it was a year ago.”

From the February 2021 all-time high to the initial price on the trade date, the ETF lost 64%.

The share price hit a 52-week low in Jan. 28 at $32.73. Since then, the ETF has slowly rebounded, positioning the price on the trade date 15.5% higher than last month’s bottom.

Kaplan said he has been buying the ETF on multiple occasions each time the price drops below $36.

“Why $36? Because it’s the point at which the growth rate of the ETF is double the price-per-earnings ratio,” he said.

“If they had priced it a day earlier at $36.28 it would have been slightly better.

“But if you put things in perspective, this is a very unpopular fund and it’s trading at a very depressed price, two good things from a value and contrarian standpoint.”

Value gem

The ETF tracks the CSI Overseas China Internet index, which consists of China-based companies whose primary businesses are focused on internet and internet-related technology.

Its top holdings include Tencent Holdings Ltd., Baidu Inc. and Alibaba Group Holding Ltd.

“It’s very rare when the growth rate is more than twice the P/E ratio. It’s an ideal value pick,” he said.

“This fund launched nine years ago. What you’re looking for is the highest profit growth during that time divided by the P/E ratio.

“Ideally, you want a P/E as low as possible and profits growing as much as possible.

“It’s an unusual feature to get such a good bargain.

“Issuers should look for more of these situations when they pick the underlying of a note.”

Under the radar

Stocks like Alibaba have plummeted since the fall of 2020 after Chinese regulators began to target internet companies. Alibaba, the fourth largest holding in the portfolio with a 6.47% weighting, lost two-thirds of its value since October 2020.

The Chinese internet sector rapidly turned out of favor as it was slow to rebound, he explained.

One persistent worry among U.S. investors is that the Chinese government may pressure some big internet companies like Alibaba to delist their stock from the United States.

Some companies like Didi Global have already announced that they will file for the delisting of the company’s ADSs from the New York Stock Exchange.

Protecting the strong

Kaplan downplayed those concerns.

“Investors are overly anxious about KWEB,” he said, referring to the ETF’s ticker.

“They wouldn’t worry about delisting a year ago when the stock was sky high. The only time you hear about those fears is when the price is worth buying,” he said.

For this contrarian investor, China’s scrutiny on its big internet companies, the equivalent of Google, Meta Platforms and Amazon, should be good news for investors.

“I’m not sure why people are interpreting China’s regulatory crackdown as a threat for the big companies.

“The restrictions really apply to new internet companies, not to the established ones. While it may not be a good thing for China in the long run, what they’re really doing here is protecting big tech and making it very difficult for new companies to compete against the giants.

“There’s been a lot of media hype, but people are misunderstanding the intentions of the Chinese government.

“China is going to crack down more on IPOs, which was the source of their conflict with Alibaba’s CEO. They want to eliminate competition from the newcomers. How can it be bad for Alibaba, Tencent and Baidu?

“China relies on U.S. investors for the financing of these big internet companies. They wouldn’t do anything to threaten their growth.”

Make a wish

Kaplan said he liked the notes based on the current value of the underlying fund.

“You have a good chance to earn 18% in one year. It’s a very good return,” he said.

“I would expect a greater rate of return. But just in case it doesn’t go up that much, you at least get 18%.

“It makes sense to buy the notes if you expect the rebound to be slow, if you think it’s going to go up only by a small amount. Someone more bullish would be long the shares.”

The 30% contingent protection on the downside was sufficient in his view.

“The share price has already fallen a lot in one year. The chances of a 30% decline are small when you’re buying something so depressed. You’re more likely to see a rebound,” he said.

“This is a fund that lost close to two-thirds of its value in one year. It’s a big drop. The stock has never been that low since the beginning of 2019 at a time when the companies were making less profit.

“This is an interesting note. The ETF trades at a bargain. The sector is still very unpopular. I wish all deals would be like that.”

Wells Fargo Securities, LLC is the agent.

The notes were expected to price on Feb. 15 and settle on Feb. 18.

The Cusip number is 78016FD76.

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