Why I Think More is Better with China Internet
KWEB's portfolio manager weighs in on why he prefers diversified exposure
Mark Schlarbaum, portfolio manager for the KraneShares CSI China Internet ETF (KWEB), recently went on a tour of China meeting with several top executives from internet firms held within KWEB. Below Mark shares his notes on the potential benefits of a diversified exposure to investing in Chinese internet stocks, how the China internet sector compares with the US internet sector, and emerging trends that were highlighted in his meetings.
As I sat waiting for my plane to depart from Los Angeles to Beijing I began to review my agenda for the forthcoming trip. I would be joining a tour organized by Macquarie Capital, one of the leading investment banks that provides research on the Asia Pacific region. I was scheduled to meet with top executives from a number of companies held by our fund, the KraneShares CSI China Internet ETF (KWEB). On the trip I would be joined by a group of large institutional investors who manage a combined $200 billion USD1. Although the institutional investors and I would be meeting with the same companies on the trip, we had two very distinct motives for making the journey.
The institutional investors are individual stock pickers whose goal is to determine which China internet stocks to invest in. As the portfolio manager for KWEB my style is different from theirs. KWEB is an exchange traded fund (ETF) offering broad exposure to the China internet sector. I don’t have to choose one stock or another because the basket approach ensures I get exposure to the entire sector.
Over the 12-hour flight I had plenty of time to think and review my notes. Today only about half (51%)2 of China’s 1.3 billion citizens have access to the internet3. In contrast, 88.5% of US population has internet access4. This means that China has room to grow in terms of internet penetration. To put this in perspective, it has been 15 years since the US had a comparable percentage of its population (49.1%) online5. Needless to say a lot has changed since then, and the landscape of publicly traded companies in the US looks far different than it used to.
In 2001, I was just like my stock picking colleagues. As a senior vice president at T. Rowe Price Associates, I was on the front lines of the US initial public offering (IPO) market. By that time things had already calmed since the peak years of early internet exuberance seen in 1999 and 2000 where companies like PETS.com, Globe.com and Etoys.com all surged and then folded. However, in 2001 fortunes were still yet to be made in companies like Priceline, Amazon, and Netflix*. One of the lessons I learned from this experience was that picking winning trends is much easier than trying to pick the best individual stock. This is the foundation for one of our core philosophies at KraneShares: within sectors and countries like China with high growth and volatility, a basket approach can potentially improve an investor’s risk adjusted returns while still offering exposure to the same exciting high growth and profitable trends of the individual companies.
On the Ground in China
When I finally arrive in Beijing and my tour commences I can’t help but notice that there is an excitement about the future in the air. All the executives I meet are entrepreneurial, enthusiastic and driven. The majority were educated in the United States and worked for companies like Google, Microsoft and Apple*. The trend is for Chinese CEOs to work at top US tech firms then return to China and put their experience to work by founding their own companies.
Just like how the US in the early 2000’s had lots of competition surrounding what were then hot new trends like search, E-Commerce, and streaming media, we see a similar phenomenon developing around new trends in China today. In many cases these trends mirror what is going on in the US right now, but in other ways China is taking a new direction. The three key trends that all the companies I met with were talking about are: social media advertising, artificial intelligence, and Online to Offline (O2O).
Social Media Advertising
One of the most interesting meetings I attended was with Zhang Rui, the founder and CEO of Social Touch*, a leading private Chinese mobile social marketing solution provider that helps clients understand their return on investment from money spent on advertising on social media platforms like Weibo6 and WeChat7. Weibo has 312 million users daily and WeChat has over 500 million users daily8. Mr. Rui believes these platforms are 2-3 years ahead of Facebook Messenger in terms of monetizing their user base. Interesting to note that of all of the ad dollars spent in the examples Social Touch provided, no one used TV or print ads, and instead opted to use social media. Mr. Rui has one of the most thorough understandings of the internet landscape in both countries that I have ever encountered and his company is helping to innovate the way brands reach their target market via Chinese social media. KWEB is well represented with the top companies profiting from this exciting trend such as Weibo, Sina, Tencent, Baidu and Alibaba.(6,7,9,10,11)
Artificial Intelligence
It’s fascinating to listen to the CEO of Baidu and learn how the firm is leveraging artificial intelligence (AI) technology to expand its business. They developed technology to predict consumer’s behavior pattern, improve user experience, and generate potential revenue. Baidu and its partner NVIDIA* are leveraging AI technology to operate self-driving cars in California right now. They also discussed the Baidu Brain, a super massive neural network with tens of billions of webpages and billions of daily search queries. If this is not impressive enough, Baidu Deep Speech technology was the ranked as a top 10 breakthrough technology for 2016 by MIT Review12. KWEB holds a large position in Baidu and will be exposed to this important and growing trend utilizing the basket approach.
Online to Offline (O2O)
O2O refers to the concept of digital activities bringing people to interact or shop in real life. The O2O business model has recently been applied to businesses like used car sales, job listings, housing rentals, second hand products, travel agencies, catering, and entertainment. One area of O2O that came up multiple times in my meetings was how quickly the second hand automobile market is growing in China. The growth of the used car industry is a logical next phase in the evolution of the Chinese car market. China has experienced a rapid adoption of automobile use and is currently the largest consumer of automobiles in the world with over 30 million units sold in 201513. The growth of the automobile market is poised to potentially benefit BitAuto14, whose core business is online auto sales of both new and used cars.
BitAuto is not the only competitor in China’s used car market, WUBA15 (which is often referred to as the Craigslist of China) has also seen its marketshare grow. Beyond used cars, Wuba is the number one platform for another O2O activity: blue collar job listings. The company hosts a whopping 600 million job fillings each year, this number is so high because the Chinese blue collar work force turns over on average 3x per year in China according to the company.16
I met the CFOs from both WUBA and BitAuto and it is exciting to hear their thoughts on China’s growing O2O trend. KWEB is well positioned to potentially benefit from the growth of O2O because it holds both BitAuto and Wuba.
Every time I visit China I get a fresh perspective on the future of internet technology and trends. In many ways China is still in the early days of internet adoption – comparable to the US in 2001. Unlike the US at that time, Chinese internet executives have learned and built upon the 15 years of experience of their US counterparts. Still, competition is fierce in China, and with new companies emerging all the time, and still others preparing to go public, we are happy to provide a diversified approach to the sector through KWEB. KWEB offers holistic exposure to the trends and opportunities within China’s exciting and dynamic internet sector.
Click here for KWEB performance as of most recent quarter end.
Diversification does not ensure a profit or guarantee against a loss.
*The stocks listed above represent 0% of KWEB net assets as of 9/30/2016
- Data from Bloomberg as of 9/30/2016
- Data from internetlivestats.com, retrieved 9/30/2016
- Data from the World Bank, retrieved 9/30/2016
- Data from internetlivestats.com, retrieved 9/30/2016
- Data from internetlivestats.com, retrieved 9/30/2016
- Weibo is 3.25% of KWEB net assets as of 9/30/2016
- WeChat is a service of Tencent, which is 10.22% of KWEB net assets as of 9/30/2016
- WeChat & Weibo user data from Social Touch presentation as of 8/30/2016
- Sina is 4.14% of KWEB net assets as of 9/30/2016
- Baidu is 8.30% of KWEB net assets as of 9/30/2016
- Alibaba is 12.36% of KWEB net assets as of 9/30/2016
- Baidu Tech Blog, “MIT Tech Review Features Baidu’s Deep Speech in Top 10 List of Breakthrough Technologies”, Feb 25, 2016
- Data from the China Association of Automobile Manufacturers as of 12/31/2015
- BitAuto is 1.33% of KWEB net assets as of 9/30/2016
- WUBA is 4.00% of KWEB net assets as of 9/30/2016
- Data from WUBA company presentation as of 8/31/2016
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