ETF Edge - The China Tech Wreck

Episode Date: March 29, 2021

CNBC’s Dom Chu fills in for Bob Pisani and discusses the China tech wreck and the Moonshot Innovators ETF with Brendan Ahern of KraneShares, Tom Lydon of ETF Trends and ETF Database and Dave Mazza, Head of Product at Direxion. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge Podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to the ETF, The Podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you're in the right place. Every week, we're bringing you compelling interviews, thoughtful market analysis, and breaking down what it all means for investors. I'm Dominic Chu, filling in for Bob Bassani. Today, we're looking under the hood at Chinese ETFs and the fallout from that state. deep Chinese internet selling in the wake of forced liquidation and a handful of regulatory

concerns. Plus, the race to innovate, how investors can bet on disruptive tech names that are still in their early days of growth and what's driving that potential upside. Here's my conversation with Brendan Ahern, CIO of Crane shares, Dave Mazza, head of product at direction investments, and Tom Leiden, CEO of ETF Trends. Gentlemen, thank you all very much for being here. I would like to start with Brendan, if possible, because your ETF is possibly tracking the epicenter of a lot of this last week's moves. What exactly can you tell us about what's happening with these Chinese internet names and how is it translating into your ETF? Yeah, thanks for the opportunity, Dom. I mean, I think we are in a bit of a rotation from the growth orientation, the work from home

stocks to a little bit of more of a balanced, balance exposure where you're seeing some of the reopening trades and the cyclical value stocks come back. And I think, I think, you know, you have an element of some of these regulatory concerns, U.S., China, you know, this situation with this hedge fund liquidation that was in a lot of these names. And it's all led to a pretty nasty downturn. At the same time, you were basically flat year-to-date since the end of 2018. We're up 280% beating the S&P 500, and I think as medium to long-term investors, we just have to swallow some of this volatility, as painful and emotionally draining as it is. We know, Brennan, if I could follow up here, the mechanics of exchange-traded funds are different than that, say, of mutual funds or separately managed accounts. We know that there's intraday price action that's happening with this K-Web ETF and all of the stocks that underlie it, most of which,

translates into trading that happens overseas how exactly has your your your logistical infrastructure been then perhaps taxed because of what's happening with this particular liquidation are at our cago's capital well i i think we've come through this is another example of where exchange traded funds are tested by market conditions and in in the case of kweb you know we had an exceptionally high trading day uh... on friday thirteen and a half million shares two-ex

uh... all-time highest trading volume. We came through it totally unscathed that a lot of these U.S. names do have dual listings in Hong Kong that allows for pricing to take place during U.S. trading hours. And again, I think this is just another example of how innovative the ETF structure is. You have 13 and a half million shares in K-Web on Friday and absolutely no issues. Now, Tom Leiden, I'll turn to you here. We're showing a graphic right now with some of the big holdings in this.

K-Web ETF. From your perspective, has the ETF industry as a whole, the infrastructure, so to speak, that makes the wheels kind of turn in the ETF industry? Have they really been that tested, given what we've been seeing? Or is this one of those situations where this is a blip on the radar longer term, and we're just going to kind of get over it in the next few weeks? Well, there've been a lot of eyes on the Chinese market dom for sure, and it's held up pretty well, as Brendan said, a lot of volume. On top of everything that happened last week, where it was kind of the perfect storm for Chinese stocks, we've seen that Chinese stocks have gone below major trend lines, 200-day average, 50-day average, which is going to accelerate the trading. It has not

stalled or halted trading in any way. And a lot of these stocks that you point out are actually traded on U.S. exchanges as well. So, so far, everything's held up really, really, really well. I think some of the key things to think about as investors are long term, are these companies going to be here five and ten years from now? And I'd say, yeah, there's definitely pressure between the U.S., where we're going to be looking at accounting standards and making sure with the new SEC commissioner coming in that some of these companies might have to open up their books a little bit more and adhere to what's going on. There's also scrutiny over in China for sure, where As you pointed out, Jack Ma was kind of silenced and put on, let's say, double secret probation

and put on the sidelines to not talk as much as he normally does. But the bottom line is these are great companies, some of the best companies in the world, and will continue to prosper in the years to come. So, Dave, I'll turn to you here. I mean, the idea that these ETFs can operate relatively smoothly in this kind of environment maybe speaks to some of the developments that we've seen in the ETF industry over the last several years, a lot of mistakes that have been learned from. What exactly in your mind has been the biggest kind of lesson that we've seen so far early in the stages of this liquidation tied to Arkegos?

Well, I think one of the key lessons here is that ETS are often where the finger pointing happens. But clearly, in this case, we're not seeing it. And in fact, to Brendan and Tom's earlier points, ETFs, particularly those focused, and owning a large portion of the names that were owned by the fund and were forced to have block sales, have performed markedably well, even with an increasing trading volume. So as ETFs have become more mainstream,

they're now being used as tools for both long-term investors and shorter-term investors to get in and out of positions relatively quickly. And as we can see, is that certainly we had been in a bit of a stock pickers market in 2020 and maybe to some extent in the early part of 2021. But as volatility has increased across the board, especially with the confluence of the political events and where valuations are, especially in some of the Chinese tech names,

we certainly saw pressure pretty materially. But as noted, the ETS have again performed really well under the face of pressure. So, David, if you don't mind, I also, your firm runs quite a few different strategies. You have an eye on the different kinds of moves and investor sentiments and flows in and out of your funds. What can you tell us about the current state of the market right now? Where is there the most interest? Has the Chinese

sell-off, has the U.S.-based media sell-off created that much of a buzz where it's now garnering all kinds of more investor attention? Or are there certain places of the market that are still kind of like the places you go to in case things do fall in value? Yeah, it's really interesting, Dom, and I know you know a bit about our business. So we have ETS that leverage and inverse, and they're really catered toward traders. They're intended to be really short-term exposures. What I find most interesting about the behavior is normally we see countercyclical behavior, meaning when markets rise, actually people start betting against it, so they move into the bear funds. Conversely, if markets down, they bet on the bull funds.

Most recently this year, we've continued to see money in the short term move into areas that had been previous winners. like semiconductors, biotech. So we're not necessarily seeing a reversal out of those areas, even though in the short term they've come off well off their hives. So we're keeping a close eye on this to really get a sense of investor behavior. For the time being, people are, in fact, doubling down on some of these bets that worked really well and then have been struggling.

Now, certainly we'll see how long people can hold that out. But money has been actually sticking on the kind of really high, growth areas focused on disruption, as I said, semis and the like, that is a bit surprising to us based up of historical standards. Brendan, I'd like to follow up with you here. Are you seeing similar type situations on your end? Mostly because the crane shares K-Web ETF that we're talking about, we're talking about the largest internet and computer sciences type companies, media type companies in the Chinese market.

It seems to be like those are the blue chips, so to speak, if you want to find something like that. Are investors going back to buying the dip? Do you think they will buy the dip? And if so, how much transparency is needed given the current state of not knowing what's going on with Arkegos and their prime brokers? Yeah, I mean, we've seen over this correction, Dominic, net inflows across our ETFs, including K-Web, K-Green, our clean technology, cars, our EV fund, KFBG or semiconductor. So I think, you know, we have a lot more non-shareholders than shareholders, and you're seeing people who want to get exposure to these quality names. I mean, we're just coming out of earnings season for the K-Web companies, just simply

fantastic earnings really across the board. You know, the Alibaba's and 10 cents get a lot of attention, but it really was across the basket that we had very, very strong revenue as well as net income growth. And so I think you're going to see this by the dip. I mean, I don't know how long. I mean, we would charge two and 20 if we could predict how long you're going to have this little cyclical value rebound. But I think for the medium to long term, especially where China being three quarters removed from their quarantine and these growth companies, the work from home companies are still generating these fantastic financial results, it just shows why investors should have exposure there. It all sounds very, very constructive and bullish, you know, Tom.

I understand the idea of buying dips. These things are on sale. and nothing's really changed. The corporate fundamentals are there. But there's got to be stuff that's worrying you. Are you seeing any of those trends in your role as the CEO of ETF trends? Any trends out there that we should be worried about? Are there things on the valuation side of things? It seems like interest rates have now taken a back seat to this discussion,

given what we've seen in the last week. How much of this is going to worry the markets, as long as things are kind of moving along these lines where we're still trying to figure out what's happening with Arcagas? Yeah, so we're still seeing record flows coming into ETF so far this year, Dom, $5.5 trillion now. But if you think about prior to COVID, it was all about the S&P 500. And with that, it was all about Fangstocks.

And Fangstocks did really, really well. Fast forward to today, they've underperformed recently when you look to other innovative areas. So there's been a lot of conversation about Kathy Wood and Arc and high concentration in certain companies. But you look at these two firms, crane shares, direction. Both have done a great job of picking certain areas where it's innovation. Innovation in China, for sure. You look at KBA, which are the A-shares ETF that they have over there. These are companies that you normally couldn't get three years ago,

but now that you can through China. And then with Moon over it, direction, these are the next fang stocks that will be coming. And many of the names that you see in the portfolio, you and I wouldn't recognize. Any worries about valuations at all, Dave, I'll turn to you for this one. Any concern, because many of these bets and these trading instruments that your firm puts out there are geared, like you said, towards short-term traders. Is there any notion, any feeling out there, any signals from your traders and investors that are trafficking in your funds, that signals perhaps there is something to be expected with regard to volatility in the coming weeks and months? Well, I do think that investors should be thinking about valuations much more sharply than maybe they did in the past. And the reason being is simply if you're just looking at price to sales, price earnings, whatever multiple you choose, they are well above historical averages.

The counterargument to that is, well, interest rates remain well below historical averages. But as interest rates potentially begin to normalize on the long end, it's going to put some short-term pressure on some of the of these more higher growth disruptive names. For example, some of the names in our Moonshot Innovator DTF that Tom mentioned Moon have seen some sharp underperformance over the last few weeks. That also comes on the heels of really, really sharp outperformance in the previous six weeks prior to that. So net net, I think investors want to probably have more balanced portfolios toward growth and value. However, if I'm thinking about growth there, I probably want to, avoid some of the bank stocks that have already seen their multiples increase so sharply

and look at some smaller micro mid-cap companies that are truly focused on disruption because there might be some more opportunities there than continuing to load up on just the four to five mega-cap growth companies that certainly have worked and they may continue to do so but you're not necessarily getting any diversification benefits at this point. Right. Brendan, China, we mentioned earlier in the show that it's not just what's happening here in the U.S. with regard to a hedge fund, possibly liquidating that's causing this. There is fundamental risk from the Chinese Communist Party with regard to how they are going to regulate those mega-cap tech and media companies in China.

They only have to find them, a million dollars, but they get the hint. How big is regulatory risk going to be for these mega-cap Chinese Internet stocks in the coming months and weeks? Well, I think ultimately these companies represent everything China. endeavors to be, you know, companies doing innovative things, well-compensated staff. They're great brand ambassadors for China, so I don't think they're going to kill the golden goose. I think these companies, yes, just as we saw in Europe, you know, in Europe in 2018 passed the GDPR, their privacy data laws, and it wasn't the end of the world for the companies that operate there. So they're

going to adhere, and we saw that, you know, 10-cent reported their earnings. and they said, their fintech unit is adhering to the new laws, right? You know, they're not allowed to lend to college students. They can't lend more than $200,000 to any individual, and they need to hold 30% of the loans that they originate. So I think that the companies will adhere to the new rules, some of that's out of necessity, but at the same time, the Chinese economy, which they want to be increasingly to be self-sufficient,

really does need the K-Web companies. So I think they'll learn to play nice in the sandbox with one another, and I think they'll learn to play by these rules, but they still have a tremendous opportunity in front of them. Now, Tom, how big of a role will Chinese funds and Chinese stocks play in investor allocations in the coming year? The idea being here that if people want to diversify,

there are places outside the U.S. that maybe have a higher growth profile, even than what we have here, is China that, I mean, I hesitate to call it an emerging market because it's the world's second-bigest economy at this point, but are there other markets out of? there besides China on the outside of the U.S. side of things that are going to become magnets for investment capital.

Yeah, well, emerging markets have been real strong lately, Dom, as you know, but you can't help but concentrate on China. It's just so dominant and going forward will continue to be dominant. You know, as these guys are saying, there's so much innovation that's going on there and they're not going to, the government is not going to shoot themselves in the foot. They are promoting innovation in a big, big way. These companies have real earnings, and it's not 1999. There's not huge, huge expensive stocks that are making up these portfolios today, and I think that's something to think about.

All good companies over time have corrections. You know Amazon corrected 90 percent three different times over the course of its history. We just have to expect that and maybe look at those as buying opportunities. Now, Dave, I mean, the big theme that has been, and Tom mentioned this before, this kind of technological innovation, disruptive technology, that type of thing could be where people want to divert some funds because they're looking for that moonshot, so to speak. Talk to us a little bit about what exactly is going to be the big move here with regard to how people will invest in what they perceive to be disruptive technology. And then what exactly is disruptive technology in your mind and what types of companies? are we talking about that will fill that particular niche in investor portfolios? Yeah, so in my opinion, thematics are really the new active management,

meaning thematic ETS, whether they're actually actively managed or being done so in a systematic way. So when we think about moonshot innovation, it's not just based up of finding the next mean stock. It's actually done in two ways. So systematically scanning corporate filings, so your 10Ks and your 2Ks and 10Ks and 10 Q's, to understand if companies are using terms in their industry, which are more associated historically with innovation than their peers. So this gives a sense of a corporate culture and vision toward innovation. But that's not enough.

You know, just trying to create an algorithm to identify words gives you a universe, but we actually make sure the companies are actually walking the walk too. So part of the scoring is does a company, again, relative to their peers, spend more on research and development relative to their sales. So when you pair those things together, you can identify a history of innovation. Now, historically, of course, Amazon, Tesla, Apple, would all have been part of the portfolio, but we purposely focus only on small, the mid-cap companies. So right now, about 40% of the portfolio is small, 30% is traditional microcap,

and then the rest is really in the mid-cap space. So the 50 names in the portfolio are going to give you exposure to everything from companies involved with genetic engineering to cybersecurity, wearables, virtual reality, and clean tech. And these are names that some folks might not be familiar with, but they're doing really exciting things. So Vuzix, microvision, immunity bio. Again, that ranges everything from companies working with smart glasses for telemedicine and warehouse use to microvision focusing on miniature lasers that are used in. 3D displays, and then immunity, it's customized cancer and disease treatments kind of based up of your individual profile. So these are challenges that companies are tackling today that are going to change the world, whether in the next year, five years, 10 years, all at the very,

very early stage of their cycle, of their profit cycle, and now would be the time to begin to think about adding some of these names, adding ETS like this. So you can still focus. focus on growth, but just do so in a different way than just the megatap growers. Brendan, I wonder it's hard enough to find these types of stocks in the U.S. markets where I would argue things are more transparent than they are in China. I would argue that things are easier because you have more kind of disclosures and people just understand that business is a little bit better than they do perhaps in China. How exactly then do you find the next big thing, the next disruptive technology company, the one that's going to change things from a small

and medium-sized company standpoint in a place like China? Well, I think it's about going to China, working with partners, boots on the ground in China, that we have a full team there. We're in constant contact on a nightly basis with our institutional brokers. And China certainly, you know, U.S. foundations, pension plans, they've been investing in Chinese private equity for 20 years now. I mean, you know, no one really brought this up when TikTok fell under the ire of the Trump administration. It turns out two of the largest shareholders were two U.S. private equity firms.

So I think we're seeing a movement from a lot of this private equity that in China has done enormously well has become public equities. Investors are getting attuned to the opportunities. How did the economies evolve to a domestic consumption? at the same time you have MSCI adding the stocks that we hold within KBA that Tom referenced to their indices. And so ultimately, investors are going to have to understand China. It's already 40 percent of MSCI emerging markets. I think in five years it will be 50 percent, and I think in 10 years it will be 60 percent of emerging markets. And that's really ultimately the value out of cranchers is endeavoring to earn the trust of investors by providing balanced insights

on what's happening in the economy and capital market. I'm waiting to see, Brendan, when China doesn't become a emerging market anymore, and it's probably a developed market because it's such a big part of these types of things, for sure. That aside, gentlemen, thank you. Tom, I want to give the last word to you. Disruptive technology is one of those big thematic type investment elements that a lot of investors are looking at because of what we've seen with the ARC-invest,

ETFs and everything else. How exactly do you see that trend playing out? Are there going to be more entrants, people trying to find that next disruptive company? And by the way, these are in many cases small and mid-cap companies. It's not exactly easy to take large positions in these things without moving the market on them. Well, a couple things, Dom. First of all, the innovation that we've seen in the ETF space just continues to be fantastic, and we applaud it on a regular basis, especially when you have companies like what these guys represent.

The big thing I think for the average advisor and the average individual investor to remember is look at your portfolio. You probably have a home country bias where a greater percent is allocated to the U.S. with a high correlation to the S&P 500, which has worked really, really well over time. However, what the COVID situation taught us is growth in innovation happens really quickly. It's almost been sped up. So you want to make sure you have a portion in these innovative companies to future-proof your portfolio. If not for you, at least for your kids and your grandkids, and there's so much out there to choose from today in a disciplined way that it gets really, really exciting.

All right. Gentlemen, thank you very much. That's Tom Lyne with ETF trends. Also Brendan Ahern of crane shares and, of course, Dave Maza. Make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge CNBC. believes new innovations create new opportunities. Here's the greater possibilities together. Learn more at Invesco.com slash QQQ, Invesco Distributors, Inc.