Citi’s market-linked notes on KraneShares ETF offer value, timely bet, portfolio manager says

By Emma Trincal

New York, Oct. 8 – Citigroup Global Markets Holdings Inc.’s 0% market-linked securities – leveraged upside participation to a cap and contingent downside due Oct. 21, 2025 linked to the KraneShares CSI China Internet ETF provide most of the attributes favored by value investors, making the notes relatively attractive, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the ETF finishes above its initial level, the payout at maturity will be par plus 1.5 times the return of the ETF subject to a cap of par plus 74% to 84%, according to an FWP filing with the Securities and Exchange Commission. The exact cap will be set at pricing.

If the ETF falls but finishes at or above the 75% barrier level, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the ETF from its initial price.

Discounted price

“This fund has already dropped more than half in price since February,” observed Kaplan.

The share price of the ETF closed at $50.09 on Friday, or 52.3% below its Feb. 17 high of $104.94.

“It’s really a bargain. I think this is one of the best aspects of this deal,” he said.

The note was also a case study in contrarian investing.

“People got scared of China’s push to regulate internet companies. They panicked and sold. This knee-jerk reaction was not guided by any fundamentals or rational analysis,” he said.

Investors were particularly worried about the possible delisting of Chinese stocks in the United States. At the end of last year, the Chinese authorities suspended the Ant Group’s public offering, a company affiliated with Alibaba Group Holding, a move that triggered anxiety among investors.

“China is cracking down on Big Tech! You had a series of negative headlines like this for months. After peaking in February, KWEB began to drop. It’s a very volatile asset that offers some of the best opportunities,” he said.

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

Some of the fund’s top holdings include Alibaba Group Holding Ltd., JD.com, Inc., Baidu, Inc. and Tencent Holdings Ltd.

“I bought some of KWEB myself on Aug. 20 at pre-market prices for $42.99. The share price went back up a little in August but remains extremely volatile and depressed.

“So, I think this deal is a really good opportunity,” Kaplan said.

Unseen value

For Kaplan, the regulatory scare among investors hid positive news never reported in the media.

“What people don’t understand is that tighter regulations in China should actually benefit internet companies. It will make it harder for competitors to come along.

“These tech companies are new businesses; they’re not established. Competitors, not regulators are the biggest threat for them. By taking certain steps to regulate the sector, the Chinese government protects their status,” he said.

Kaplan also emphasized the disconnect between the share price of the ETF and the profitability of its components.

“Most of the headlines have been negative. But many of those Chinese internet companies in KWEB have reported very strong earnings over the past few quarters, something the media have failed to notice,” he said.

“Profits have actually increased for companies like Alibaba, Baidu and JD. Just like Amazon in the U.S., those companies have enjoyed rising profits during the pandemic, but unlike Amazon, they’re not trading at huge premium. They’re deeply undervalued.”

Kaplan emphasized the appeal of an unpopular, mispriced asset offering hidden value.

“I like the undervalued price of the fund. Picking an unpopular asset in our view is perhaps one of the most important things,” he said.

“People tend not to look at profits. They look at headlines.

“For contrarian investors like us, nothing is more exciting than a panicking crowd selling stocks of undervalued, high-growth companies.”

Terms

Kaplan said he was comfortable with the investment holding period of the notes.

“Over a four-year period, the ETF is likely to go up a lot. You’re not giving up a lot of dividends because these stocks do not pay high dividends.

“If it’s down in four years, at least you have some downside protection.

“I would think the cap is going to be more of a problem,” he said.

One way to overcome this “problem” was to combine the notes with a direct equity investment in the ETF, he said.

“You buy both the note and the fund. If KWEB rallies a lot, you’ll get its full return. If it goes down a little bit or up a little bit, you’re going to do better with the note.

“I think it’s a reasonable deal,” he said.

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the agent.

The notes will price on Oct. 18 and settle on Oct. 21.

The Cusip number is 17329UCT6.

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