BofA’s $500,000 contingent income autocalls on KraneShares China offer contrarian play

By Emma Trincal

New York, June 2 – BofA Finance LLC’s $500,000 of contingent income autocallable yield notes due May 21, 2026 linked to the KraneShares CSI China Internet ETF give noteholders exposure to an unloved and undervalued sector, which is ideal for contrarian and value investors alike, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

Each quarter, the notes will pay a contingent coupon at the rate of 22.1% per year if the ETF closes at or above its coupon barrier level, 80% of its initial level, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called automatically at par if the ETF closes at or above its initial level on any quarterly observation date after six months.

The payout at maturity will be par unless the ETF finishes below its threshold level, 70% of its initial level, in which case investors will be exposed to the decline of the ETF.

“I like the underlying. It’s a good choice because KWEB trades at a deeply discounted price. It’s also a very unpopular ETF due to irrational fears,” said Kaplan.

“In addition to that, the fund consists of companies showing pretty good fundamentals,” he said.

The KraneShares CSI China Internet ETF is listed on the NYSE Arca under the ticker “KWEB.”

The ETF tracks the stocks of China-based companies involved in the internet and internet-related technology. The fund has 35 holdings, including Tencent Holdings Ltd., Alibaba Group Holding Ltd., Baidu Inc. and JD.com Inc., which are among the best-known names and the top 10 components.

Divergence

The share price of the KraneShares CSI China Internet fund peaked in February 2021 at about $103, he noted. On Friday, it was trading around $27 in late afternoon session.

“During the coronavirus collapse, which began in February 2020, most assets dropped across the world. But from March 2020 to February 2021, the world enjoyed a ‘huge’ rebound,” he said.

However, starting in February 2021, a divergence between the U.S. markets and other regions of the world began to be seen, he said.

“Everybody piled into U.S. mega cap stocks, which continued to soar until January 2022. But the share price of KWEB during that time collapsed. U.S. stocks dropped in January 2022 but recovered a few months later in October. KWEB began to recover a little at that time but hasn’t gone up that much. In fact, it’s down this year.”

This situation is not unique to China, he noted.

“We now have a record divergence between the U.S. and the rest of the world,” he said.

U.S. focus

For Kaplan, such divergence may help explain the depressed price of the KraneShares CSI China Internet fund.

“Part of this decline is because investors are magnetized by a few big names in the U.S. which are now driving a big tech rally,” he said, adding that the bullishness was centered on a small group of U.S. technology companies, including Apple, Amazon, Nvidia and Alphabet.

“While people are crowding into these stocks, the rest of the world is left behind. And because KWEB has not been performing very well, investors avoid the ETF.

“U.S. big tech is very trendy. People are chasing momentum. The reasoning is: why should I own a stock going down if I can buy one that’s going up?

“So that’s the first factor,” he said.

Fundamentals

The second explanation lied in what Kaplan considers a misperception from the Western media of the economic interests of the Chinese government.

“The media went into overdrive about China’s regulatory crackdown,” he said.

“U.S. investors were spooked about the perceived risk of the Chinese authorities to over-regulate big tech in China. They forgot that many of those companies, those which are the top holdings of KWEB, have very healthy balance sheets and are doing quite well,” he noted.

“Big tech” in China consists of companies that are growing “much faster” than their U.S. counterparts, he said.

“They’re growing at a clip of 10% to 15% a year. They also have a lot less debt.”

He said that Alibaba, for instance, the global technology platform specializing in e-commerce, has better price-per-earnings, price-to-book and profit growth than Amazon.

“Those Chinese companies are growing faster and showing more consistent profits than U.S. big tech,” he said.

Misperception

What drives investors away from the Chinese internet ETF is based on misperceptions about the Chinese economy, he said.

“This fear that the Chinese government is going to step in and regulate those companies is totally overblown. It is an irrational fear,” he said.

Investors should be more concerned about U.S. government intervention, he said.

“The Chinese authorities depend on the profitability of these companies. They have no incentive to put the brakes on their growth. If anything, U.S. mega cap companies are facing much greater threats because there is a bipartisan consensus to regulate social media, AI and big tech in general. Policymakers on both sides want to raise taxes and impose new regulations on Silicon Valley. Those ideas are very popular,” he said.

Structure

The notes, which are not bullish since the upside is capped by the coupon, nevertheless offered an attractive payout and risk-return for investors seeking to bet on the recovery of the Chinese fund.

“It’s a good structure. You’re not likely to get huge gains in the next few years because we’re heading into a period of declining asset prices. So, the coupon is not that much of an issue. If we have a rally, you’re giving up some upside but 22% is still a pretty good rate of return,” he said.

“On the downside, there is always a chance of going below the 70% level. But KWEB is a relatively depressed fund, so the risk is somewhat limited.”

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the agent.

The notes settled on May 23.

The Cusip number is 09709VY26.

The fee is 0.6%.

© 2015 Prospect News.
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