On an episode of Animal Spirits’ “Talk Your Book”, Brendan Ahern provides insights and updates on China's Mainland markets, the history of the markets, and how to invest in some of the biggest Chinese companies through the KraneShares Bosera MSCI China A 50 Connect Index ETF (Ticker: KBA).

Highlights from the podcast:

• Update on Mainland Chinese markets
• Update on Chinese stock listing in the US
• How to invest in China's largest companies

See below for the full transcript.

---

For KBA standard performance, top 10 holdings, risks, and other fund information, please click here.

---

Ben Carlson (00:00):

Today's Animal Spirits Talk Your Book is brought to you by KraneShares. Go to kraneshares.com to learn about KBA, the MSCI China 50 Index ETF we're going to be talking about today. And also go to their mailing list, China Last Night to enjoy either daily or weekly news all about China.

Speaker 2 (00:17):

Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching.

Speaker 3 (00:28):

Michael Batnik and Ben Carlson work for Ritholtz Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

Michael Batnik (00:49):

Welcome to Animal Spirits with Michael and Ben. On today's show, we have Brendan Ahern on from KraneShares to talk all about China. I remember one of the first blog posts that I did on the stock market does not equal the economy was a post or a research piece from Vanguard that I copied and pasted into my own showing like a scatter plot of GDP and stock market performance. And if there's any sort of economic linkage, I feel like China breaks the rule, because the GDP has gone up like 6% a year. Or, well, I made up that number. Sorry. I don't know why I made that up.

Ben Carlson (01:26):

I think it's like 8% to 9% a year.

Michael Batnik (01:29):

8% to 9%. Okay. And what has the stock market done over the long haul?

Ben Carlson (01:31):

Since 1993? It's up 1% a year, 33% in total. Also, I think I did that same exact blog post early in my blog post taste, still that same chart from Vanguard. So ...

Michael Batnik (01:40):

It's a rite of passage.

Ben Carlson (01:42):

Yeah, you have to do it. Stock market is not the economy, especially in China. It's done a lot better in the last 10, 15, 20 years than it has over the last 30 years. But it's an emerging market, or it was for a while still. It's the kind of country that if you think about what it is and how it works, it kind of boggles the mind, that they just kind of have these people who are pulling different strings and levers and they can make stuff happen very quickly if they want.

Michael Batnik (02:06):

Brendan's gave us [inaudible 00:02:08] on the show, talking about the scope or size, vastness, if you will, of physical China. They have 128 cities with over a million residents for reference. The United States has about 28.

Ben Carlson (02:25):

I was impressed. When you asked him about that, the US, that he had that stat too. He had the follow-up. I was impressed with that.

Michael Batnik (02:30):

Yeah, he got stats.

Ben Carlson (02:31):

Isn't it funny though? I can remember seeing the presentations in 2008, 2009, 2010, of the ghost cities in China. That was a big bears thing back in the day for the double-dip recession. China's building. And you'd see the pictures and it's these huge skyscrapers.

Michael Batnik (02:46):

Yeah. Whatever happened to those cities? Did they ever get filled up? I feel like Vice did like a million specials on them.

Ben Carlson (02:50):

There was a lot of that. And I don't know. You don't get the follow-up. You get the initial bearish seed planted. And then what?

Michael Batnik (02:56):

Dammit, we should have asked Brendan. There was so much to talk about. We also didn't want to talk about-

Ben Carlson (03:00):

Well, he mentioned it in our talk with him. He said, "Guess what? A lot of that gap has been filled." There are these ghost cities built and then cities keep expanding and expanding and expanding. And eventually, it happens where it becomes part of a suburb.

Michael Batnik (03:12):

So on today's show, we spoke about the Chinese market. Ben, what's so funny?

Ben Carlson (03:17):

I don't know.

Michael Batnik (03:20):

Well, we're struggling for [inaudible 00:03:22]

Ben Carlson (03:23):

You missed it when he said it, and then you just skipped over when I said it. And you just chose to ignore both of us. It's okay.

Michael Batnik (03:32):

All right. So with no further ado, let's not step on too much on the material. Here is our conversation with Brendan Ahern from KraneShares. We're joined today by Brendan Ahern. Brendan is the CIO of KraneShares. Brendan, thank you for coming on today. Thank

Brendan Ahern (03:47):

You so much, Michael. Good to see you as well as Ben.

Michael Batnik (03:49):

So we've spoken about KraneShares over the week as I guess a reference point for what's going on in China specifically. We tend to talk a lot about KWEB, the internet fund, but today we're going to talk about a different one, another Chinese fund, which we'll get to in a second. But before we do, can you give us an update? Because you write a nightly newsletter. What's it called? Something about in China. Last Night in China.

---

For KWEB standard performance, top 10 holdings, risks, and other fund information, please click here.

---

Brendan Ahern (04:13):

No. Chinalastnight.com.

Michael Batnik (04:15):

China Last Night. All right. Close enough. So there was a lot happening in that side of the world right now. Can you give us the latest?

Brendan Ahern (04:22):

Ultimately you've got almost two different definitions of China. You've got onshore China, which is the Shanghai and Shenzhen market, which is 95% owned by investors in China and is more reflective of what do the Chinese think about China. And we can kind of contrast that with the offshore market, the Hong Kong, US listed ADRs, kind of like the KWEB names.

Michael Batnik (04:46):

I'm sorry, I'm a chronic interrupter, but I think this is important before we get too far afield. What is the difference between the Shanghai and the Shenzhen?

Brendan Ahern (04:52):

So the Shanghai is mega-cap and large caps. I'd call it like the New York Stock Exchange. More established companies, larger companies, and mainly state-owned enterprises. So companies that have some level of government affiliation, versus the Shenzhen exchange is more the private companies. There are some large-cap companies there, but mainly mid and small-cap names. More private companies, companies with no affiliation with the government. Think about Shanghai, more value, versus more Shenzhen more growth names. And the New York Stock Exchange would hate to be considered value. But back in the day, it was more value names where NASDAQ was more growth names. So kind of a similar comparison.

Michael Batnik (05:40):

All right. So go on.

Brendan Ahern (05:41):

Ultimately on the offshore market, I think what foreigners are worried about is a whole litany of issues. I don't know if an hour we can cover them all, but you've got the zero COVID policy, which we kind of say is, in China, they call it the lives first policy. Which is very simply that only 20% of 80-year-olds in China have gotten three vaccines. For 70 to 80, it's just about 50%. And for over 60 to 69 demographic, it's about 56%. So why China has this zero COVID policy is just ... you take a thing like Omicron, it would kill almost two million Chinese.

Brendan Ahern (06:20):

The key is that post-Shanghai, we've not seen a citywide lockdown. And I think that's very simply driven by the economic consequence of the Shanghai lockdown has led to them saying, "We just can't go through that economically." So you're seeing individual buildings can get locked down. Apartment complexes can get locked down. We're not seeing anything like what we saw with Shanghai.

Ben Carlson (06:47):

If you look at the MSCI indexes, they have all the country ones, and I've seen China's used in a ton of examples of stocks versus the economy. So I think the China one goes back to 1993. And if you look at that, the total return is like 30% or something. It's like 1% a year. I think a lot of that was the nineties were just really, really bad. And it's probably been better this century, but what are some of the reasons that those returns are just so awful over a 30-year period versus how things are different going forward, maybe?

Brendan Ahern (07:17):

It's a great observation and it's not inaccurate. People will say China's similar to EM is out of favor. And I pull this up every day. But so since the GFC low, March 9th of '09, the S&P 500 is up 215%. And MSCI, emerging markets is up 199 and MSCI China is up 163.

Brendan Ahern (07:42):

So people would say, oh, it's out of favor. I would argue, Ben, that if we went back 13 years ago and looked at the two indices, they were basically value indices, that there was all financials, energy, industrials materials, and real estate. And we went into this growth-geared market. And that was true in the US, but it was true globally.

Brendan Ahern (08:05):

And so part of what we've tried to do at KraneShares is to say if you want this growth part of China or EM, you got to go out and buy it because it's such a small part of these broader indices. So just to kind of prove that out, again, so S&P 715, EM 199, MSCI China 163.

Michael Batnik (08:28):

What are those numbers?

Brendan Ahern (08:29):

Those are percent returns from March 9th, '09, the GFC low, up until Friday the 19.

Michael Batnik (08:39):

Okay. Because as I said, the numbers that you gave just a second ago didn't seem right. The 200%. We're up way more than that.

Brendan Ahern (08:43):

Oh, so S&P 500 is up 715.

Michael Batnik (08:46):

Okay.

Brendan Ahern (08:47):

But MSCI emerging markets is up 199, MSCI China up 163. So what's a gross sector? Okay. So tech, so MSCI EM tech is up 816%. And MSCI China tech is up 2127%.

Michael Batnik (09:08):

But what if you missed the low?

Brendan Ahern (09:10):

If we did it over any time period, over the last decade, if you owned growth EM or growth China, you did very well up until about two years ago.

Ben Carlson (09:23):

It seems like that's the story everywhere outside of the US. European stocks and developed stocks, foreign developed anything. It was just more of a value tilt, right?

Brendan Ahern (09:30):

Yeah. Yeah. I mean, people will always talk about the Kos fee, the definition of South Korea, but they have a thing called the KosDaq and the Kos fee didn't do anything for 10 years while the KosDaq did nothing but go up. So this value versus growth, it's not just a US phenomenon. It really has been a global phenomenon. And you have these benchmarks that are all value. And then you have this growth out-performance. And of course, the market does what's least expected. Energy prices, commodity prices go up and the benchmarks have little exposure to that. In some ways, it's just very typical or predictable. In some ways.

Michael Batnik (10:13):

Brandon, I saw a tweet over the weekend, Sichuan province just announced a shutdown of all industrial production for fivefold days due to electricity shortage. You know about this?

Brendan Ahern (10:22):

Yeah. Yeah. It's interesting. Sichuan Providence. I mean, they've got some good companies, industrial companies. What will shock people is 80% of that province's electricity is hydro. And so you have this crazy heat wave in China. And this province gets virtually all of its energy from hydroelectrical dams. Heatwave equals drought means no electricity.

Ben Carlson (10:51):

Michael, you asking a China expert if he's heard of this is kind of like someone asking you if you saw a horrible horror movie last weekend. Of course. Of course, he's heard of it. No.

Brendan Ahern (11:01):

Well, hopefully, that's some sort of job security. They've had a bad heat wave, very similar to what we've seen in Europe, actually in parts of the United States. And it's interesting. Some states like Vermont, very dependent upon hydro. And so if you get a heat wave, which leads to a drought, you got a big problem.

Ben Carlson (11:18):

Getting back to the growth value stuff real quick. Does that mean that a lot of these EM indices are now way more growthy because these are stocks that have outperformed in the last decade?

Brendan Ahern (11:27):

Yeah. Yeah. I mean, that's exactly it, Ben. Part of it was MSCI didn't add US-listed China ADRs like Alibaba until the end of 2015 and 2016. So IEMG or EEM didn't hold Alibaba until December of 2015. And then again in, I think it was June of 2016, it was a two-stage inclusion. FTSE, if you own VWO, they did 2016, 2017 inclusion of US-listed China ADRs. So if you bought the blob, you didn't actually own one of the largest companies in the EM universe because it wasn't part of the indices.

Michael Batnik (12:07):

All right. We're going to get into the A-shares in a minute, but I can't let this go without talking about [inaudible 00:12:12] for a second. Because I'm looking at the return charter, the price charts, this inception, and this is a wild one. I mean, this really is a wild one. If you zoom back to 2020 and the run-up that it had with all of these giants, primarily driven by Tencent by [inaudible 00:12:31] Baba, JD, those names, it almost seemed like last year, the government, not almost, it was very explicit that the government was going after these companies. And it was just from the centric point of view, kind of amazing to watch the government seemingly turn on these companies. Can you explain to us what exactly was the motivation for nuking these companies and where we are today? Are we on the other side? What's going on?

Brendan Ahern (12:59):

Part of the run-up and then part of the meltdown was Archegos. You've got this US hedge fund is levered up 10X or whatever. Five of their 10 names where us China ADRs. And so they were in Tencent music, which went from 10 to 30 and you're just like, what? And people were like, well, how does that affect? But because of relative valuation, it affects the whole space.

Brendan Ahern (13:24):

And then when they got liquidated, those names got sold out at 50% where they had closed previously. So some of this was Archegos, but then yeah. So then the China internet regulation ... I think it was part of where, as an outsider, you'd be like, well, they're trying to kill the tech companies. But I think what they were saying is that the multifaceted nature of it, where you had multiple regulators moving at different speeds, it was almost like they were like a Whack-a-Mole. Like every week it was one name.

Brendan Ahern (13:57):

It was Alibaba one week and then Tencent the next. And you had the companies. It was kind of an anti-monopoly. Some of it was anti-monopolies. Some of this was anti-competitive rules. Alibaba just started advertising on Tencent's social media platform for the first time because they weren't allowed. Alibaba wouldn't accept Tencent's mobile payments. So these moats around the companies have come down. And I think it was how they did it. The lack of transparency and communication pushed a lot of investors out of these names. Just said, "If I don't understand what's going on, I'll just kick it to the curb. I'll just get out of it."

Ben Carlson (14:37):

Is there any hope for investors in these companies that the government is going to reverse course?

Brendan Ahern (14:42):

From what we've seen, we're not really concerned about China internet regulation that we think it's been recognized, how they went about it. It was poorly done. There's multiple data points to say that on the China internet regulations side, the worst is behind us. We're probably a little more concerned about US regulations in terms of the potential delisting, where we've taken this law that did pass very seriously, the holding foreign companies accountable act, and we've converted a lot of KWEB out of the US ADRs because of the potential delisting risk, which we think will get avoided. You just don't know if it gets solved at 11:59 and as a fiduciary, you're not going to take that risk.

Michael Batnik (15:28):

So maybe this is a good opportunity to segue to the KraneShares, both [inaudible 00:15:32] MSCI China A 50 Connect Index. That rolls right off the tongue. The ticker is KBA. So you mentioned the Holding Foreign Countries Accountable Act, which requires foreign listed companies and makes them open up their books for audit approval by us regulators, which seems kind of normal. But there's a lot of resistance on, I don't know if it's a government or these companies or whatever. So part of the fear of investors, and I feel like this flares up in the headlines once every six weeks, is that some of these ADRs are going to get delisted. What are the chance of that happening, and in English, what does that actually mean for people that are investing in B-A-B-A.

Brendan Ahern (16:13):

We've moved-

Michael Batnik (16:13):

I don't know why I just said B-A-B-A.

Brendan Ahern (16:15):

Yeah. BABA?

Ben Carlson (16:17):

Is that how it's spelled like?

Brendan Ahern (16:19):

We've moved. I mean, we don't hold Alibaba US anymore. We own 9988 HK, the Hong Kong. So I think this does get resolved because I think it's a solvable issue. Yes. China should allow the companies and it's really the company's auditors to allow an audit review.

Michael Batnik (16:36):

Is it China saying, no, you will not? Okay. But why? Why not just be transparent? I mean, I think I know why, but you tell us.

Brendan Ahern (16:42):

It's because amongst the 273 names, as US-listed China names, you have a small number of state-owned enterprises. So if you think about what's an audit review? Well, it's like, what are the inputs and outputs to the balance sheet, to the net income statement?

Brendan Ahern (16:58):

If you're a private company, what do you care? You got nothing to hide. If you're a state on enterprise, maybe that is problematic because maybe you're getting subsidies. So we actually think recently it was announced five ADRs will delist from the New York stock exchange. They all are state-owned enterprises.

Brendan Ahern (17:16):

So if the SOEs go away, wouldn't that allow the private companies to adhere to this global standard? I would say yes. I mean, out of 273 names, the five names that say they're going to delist all are SOEs. Five for five, out of 273, like statistically-

Michael Batnik (17:33):

What are the ramifications of a de-listing both for the investor and for the company?

Brendan Ahern (17:38):

It's hard. I think that's the hard part is we don't know exactly how. I mean we have a little time, the de-listing wouldn't actually probably take place until 2024. There was a movement to try to shorten the window, which thankfully wasn't included. Congress didn't take up on it. But ultimately a de-listing could mean that it's a zero.

Brendan Ahern (18:00):

HFCAA was written that the companies can't trade over the counter. They can't go to the pink sheets. So small companies would take themselves private. The big companies could push through that. Many of them have re-listed in Hong Kong. So they could just do a forced conversion into the Hong Kong share classes. And I think that's something that why, again, it goes through, it would be very kind of messy. And I think ultimately this is a very solvable issue. This is not a hard one.

Michael Batnik (18:31):

So what's the solution?

Brendan Ahern (18:32):

Well, ultimately the SOEs listed in the US go away, and then the private companies are allowed to hear to this global standard. There's no reason that they shouldn't be allowed to. Alibaba's old CFO, she used to always say, "We have nothing to hide." Under board, actually, they just hired the head of Ernst & Young. I think it was Ernst & Young China. It's actually on their board.

Ben Carlson (18:55):

If that happened, how many US funds are we talking about here that would be impacted? Are there a ton of funds that have exposure to these stocks that would be hurt in a big way?

Brendan Ahern (19:05):

Institutional asset managers, mutual funds, for us, when we convert it, you simply tell your custodian you want to convert. They contact the ADR custodial bank and it's literally a book entry. It's like, okay. Instead of holding BABA US, you own Alibaba, Hong Kong.

Ben Carlson (19:24):

Oh. So it wasn't that hard of a project for you.

Brendan Ahern (19:26):

No. Oh, I mean, it was very, very easy to do. It's a tax-free conversion. The ADR custody bank will charge you like four or five cents a share. The issue is more of not all US investors want to or can hold a Hong Kong share class.

Brendan Ahern (19:43):

So think about the QQQ owns Baidu, JD, and NetEase. Then NASDAQ 100 isn't going to convert. They're going to be forced to sell those three stocks. It's not a huge position. But think about all different RIAs or family offices or individual investors who maybe can't convert. Not all US broker deal or not all because allow for ADR conversion. That's the problem. That's why we've advocated that the window shouldn't get shortened. Just because there's an operations element that hasn't been figured out.

Michael Batnik (20:18):

Brendan, does KraneShares have a voice at all? Are you guys talking with the Chinese regulators about some sort of voice for US securities for lack of a better word?

Brendan Ahern (20:29):

We've done both sides as well as we've spent a lot of time in Washington, DC, trying to explain to Congress that this bill doesn't hurt China. The Chinese government doesn't hold these stocks. US investors do. Why would you put two trillion of US investors savings at risk?

Michael Batnik (20:49):

When you say two trillion, what do you mean by that?

Brendan Ahern (20:51):

That's the aggregate market cap of the 273 names. So this bill was done to hurt China or the Chinese government, but Chinese government doesn't hold these stocks. US investors do.

Michael Batnik (21:03):

What do the regulators say when you say that to them?

Brendan Ahern (21:05):

They would say, "Well, A, this law was passed by Congress and signed by an outgoing president." So the SEC is simply the enforcement agency. Not their opinion to opine on ... they're the enforcement agent. Gary Gensler has no choice, but to enforce it. This was done simply by Congress.

Brendan Ahern (21:28):

And the other argument is, well, these companies were allowed to list here. It's not like they snuck on the exchange. Every one of these companies was approved to list here knowing they couldn't adhere to Sarbanes Oxley, which was passed back in 2003. So this was more of just law was passed to basically force the Chinese government to do something. And I'm just like, man, my kids tell me all the time. They don't like to be told what to do. That's the risk.

Ben Carlson (21:57):

The thing about China to me, though, always kind of blows my mind is how big it is and how it seems like they can kind of pull these levers and make things happen very quickly. So you understanding the situation better than me, if China really said, "You know what? We want to make the stock market at the forefront of our economy," kind of like it is in USA, do they have the levers they could pull that would say, "We want the stock market to go up a lot." They could do that potentially?

Brendan Ahern (22:18):

Well, sort of. Sort of. I mean, it'd be no different than a J Powell or trying to Jawbone the market. There are government investment entities. They have a social security fund. So back in the summer of 2015, when the market, the mainland market, performed very poorly, they increased the equity allocation of the social security fund. They increased the equity allocation for insurance companies' general accounts. So they do have a few sovereign wealth funds that can buy equities. But these markets, Shanghai, Shenzhen, taken together, is the second largest stock market in the world behind the US. So even though they've got a lot of money, it's small relative to the size. It's a 14, $15 trillion market cap in mainland China.

Michael Batnik (23:12):

Why is the GDP of China relative to the overall pie of the globe So much larger than the stock market presence?

Brendan Ahern (23:21):

It's driven partially by China has a socialist element to the country, but their safety net in terms of social security is much smaller than here in the US. If you get fired and lose your job, unemployment insurance, it's small. But the Chinese citizens are really responsible for their own retirement. And therefore, they have been very conservative with how they invest. And because of the higher yields historically available in China, most of it goes into bank accounts and the bond market. A bigger piece goes into real estate. And then the what's left over kind of goes into the stock market.

Brendan Ahern (24:06):

Now that percentage of stock market savings is increasing. But part of it has been in real estate. I grew up with family in Denver and if you've followed Denver for 20 years, it's like mind-blowing where just the city, I mean from Stapleton Airports, and now there's DIA and Denver International was out in the middle of nowhere. And now the city goes all the way out. I remember as a kid, we went to see a Colorado Buffalo football game and between Denver and Boulder, it was farmland. And now it's a suburb the whole way. But that's Chinese cities.

Michael Batnik (24:43):

Wait, hold on. I missed this. Which province is Denver in?

Brendan Ahern (24:46):

Yeah, well just that these cities get bigger and bigger and bigger. So in China, in 1980, 20% of people lived in cities. Now it's closer to 70%. So if you think about a city just getting bigger and bigger, you're like, oh, I'm just going to buy. I'm going to build a building. That was kind of the misnomer of the ghost city, was like, these cities just get bigger and bigger. So it's been a one-way trade and-

Michael Batnik (25:11):

How many Manhattan size cities are there in China?

Brendan Ahern (25:13):

There's 130 cities that have more than a million people.

Michael Batnik (25:18):

What's that for comparison to the United States?

Brendan Ahern (25:20):

28 kind of geographic areas.

Michael Batnik (25:24):

Okay. Wow.

Brendan Ahern (25:26):

The city of San Francisco is like 800,000 people. The bay area's 15 million or something. I kind of use the geographic area as opposed to city.

Michael Batnik (26:17):

Brendan, make the case for A-shares. What's going on here? What do investors need to know?

Brendan Ahern (26:20):

I think it's part of what's really weighed on this disparity between what foreigners think about China and what do people in China think about China and the Chinese historically are far less pessimistic. And it's not that they don't have access to Western media, which is this kind of constant negative media barrage. It's more, they just don't buy into it, that they would say that things that really matter are government policy. And right now, you have China's in an easing cycle. They cut the loan prime rate. They've cut the intra-bank lending rate. They're easing because they recognize that the economy needs support. And that's a great tailwind for investors. Also, for investors in China, as interest rates drop the greatest bull market in government treasuries globally right now is in China. I might be the only person in the planet that we have a KBND. We have a China government bond that Chinese treasuries have rallied pretty significantly as they ease.

---

For KBND standard performance, top 10 holdings, risks, and other fund information, please click here.

---

Michael Batnik (27:26):

Why are they so disconnected from the rest of the world? It feels like there's like a global central bank coordination with the world. And then China's on its own island.

Brendan Ahern (27:34):

It's just more the China, the economy rebound. This is where China's almost like a year ahead of everybody else. They got COVID first. They came out of it first. And now they've got this little bit of a slump kind of post that economic rebound. And some of this is driven by what's happening in real estate. So the government is incrementally adding support. And I think if you think about yourself, with free stimulus money from central banks globally, we went out and bought stuff. And a lot of that stuff was made in China.

Michael Batnik (28:08):

I wonder if my tropical bro shorts are made in China.

Brendan Ahern (28:11):

Most clothing, low-end clothing, not to point the finger at your ...

Michael Batnik (28:16):

[inaudible 00:28:16]. It's all right.

Ben Carlson (28:18):

[inaudible 00:28:18].

Brendan Ahern (28:19):

Low-end clothing is moved out. It's because China's gotten too expensive.

Michael Batnik (28:23):

All right. We might have glossed over the fact or taken for granted that people have any idea what we're talking about when we say A-shares. What are A-shares and how difficult or easy was it for you to access that market? And tell us how you're doing it.

Brendan Ahern (28:37):

Candidly, part of why I quit my job to come to KraneShares, to be part of making John Krane's vision investible was, I had this kind of passive background. I've worked for iShares for many years. And so, John had been in China and saw how new China economic sectors were coming about, and that was KWEB. But then, he saw, living in China, how they were opening up to foreign investors. And so when I met John in 2012, he simply said, "You've got this Shanghai Shenzhen market. It's not owned by any foreign investors, but these reforms are going to allow this market to be owned by foreign investors."

Brendan Ahern (29:17):

So I thought about it just from a passive investors' perspective, which is if you've got the second largest stock market in the world and they're giving this access, then it can get added to indices. And if you think about this happened with Tesla and the S&P 500. What happened before Tesla got added to S&P 500? You're like, oh my gosh. SPY, IVV, VOO have to buy it. Why wouldn't I just buy it before them?

Brendan Ahern (29:44):

And that's kind of what I thought about this, what became KBA, was if we can create MSCI's definition of this Shanghai Shenzhen market in advance of it being added to indices, that's a no-brainer. So MSCI dictates 15 trillion of active and passive assets. About 1.5 trillion is EM and the stocks and KBA would be about 20% of MSCI emerging markets. So 20%, 1.5 trillion, to about 300 billion of inflow. That was my thought was that you had these stocks that weren't part of a major, major index could go into them.

Michael Batnik (30:26):

Because the A-shares were only available to Chinese investors.

Brendan Ahern (30:29):

Correct. Correct.

Ben Carlson (30:32):

So where are we on the timeline of that then? Is there any action happening then?

Brendan Ahern (30:36):

In 2019, MSCI announced that they would add the Chinese A-shares to their indices, including EM, but they only were going to add 20% of their potential weight. So if you look at MSCI China today, it's like 700 stocks. 500 of them are Chinese A-shares that makeup 8% of the fund. And so you would say you have 80% to go. And I think because of the trade war and tech war, there's some other reasons why MSCI hasn't added the kind of technical stuff, but I think they've stopped this inclusion. So we're only 20% there.

Michael Batnik (31:22):

Brendan. I know you don't have full transparency into who the holder of these products are, but any sense of the demographic makeup of your investors? Is that family office? Is it RIAs?

Brendan Ahern (31:32):

It's all of the above. I mean, I would say getting access to these names or getting access to Alibaba in Hong Kong, that's why people are hiring us. So that could be RIAs. It could be wealth management firms. It is institutional. It's pension plans. We've got a big pension plan that they own KBA because they don't want to go through the rigamarole of getting access into mainland China. They're just like, hey, you just type KBA. And you've got access to these stocks in Shanghai Shenzhen versus trying to operationally get access. So it's-

Michael Batnik (32:08):

Why futures?

Brendan Ahern (32:09):

We need to hold the physical stocks.

Michael Batnik (32:12):

Oh, all right. So delete that question.

Brendan Ahern (32:14):

What's interesting about it, Michael, is that MSCI historically said, and when they did the 20% inclusion into MSCI emerging markets, MSCI China, these stocks we hold in KBA, they then said, "Well, there's three things we want before we'll get this inclusion going again." And one was to get an MSCI China, A-futures listed in Hong Kong. That actually just happened almost a year ago. It happened in the fall of 2021.

Brendan Ahern (32:45):

Two, they said, "Well, Hong Kong has a different holiday schedule than mainland China." So that limits the number of days to be able to get your money into and out. And they just said that they changed those rules. That happened a week ago. The third issue for MSCI on why they stopped this inclusion, and again, two out of three are done, is Chinese stocks and the stocks in KBA trade T plus zero. So-

Michael Batnik (33:15):

Does that mean? T plus zero. Is that instant settlement?

Brendan Ahern (33:17):

Instant settlement. It's one of the misnomers, is that you actually can't really day trade in China because you owe the money at the end of the day for the stock you bought that day. Now, why that's a problem for MSCI is if I'm an asset manager and I need to buy China and, say, sell Europe or sell US, I don't get that money until T plus two. So for index managers who have to buy and sell on the same day, China being T plus zero is actually a problem. Because I'm going to increase China, which means I have to raise the cash, but I don't get that cash for two days. But for China, I have to settle at the end of the day. So China's actually too fast relative to other markets.

Michael Batnik (34:11):

Brendan, where do we send people to get your daily insights?

Brendan Ahern (34:16):

We write chinalastnight.com. So it's a free website. You can sign up for daily or weekly. For most people knowing daily's not necessary.

Michael Batnik (34:27):

That's a great innovation. I feel like more places should do that. The daily versus weekly option. I like that.

Brendan Ahern (34:33):

Optionality. We're all for it.

Michael Batnik (34:34):

Credit to you. All right, what else?

Brendan Ahern (34:36):

And then on KraneShares.com, you can sign up for ... so the blog, we don't talk about the ETF tickers. It's just more of what's happening in the market. And then for various fund-specific stuff on kraneshares.com. You can sign up and we always lead with the research. So it's not like you sign up for KraneShares research, you're getting like this hard sell. You got to earn that trust. And if you come on with a hard sell, that turns people off. So they're not going to subscribe.

Michael Batnik (35:02):

All right, Brendan, did you have fun? Most importantly.

Brendan Ahern (35:05):

I did. I did. I wish it was in person. I know Michael, I was feeling bad. I know the-

Michael Batnik (35:10):

Why?

Brendan Ahern (35:12):

[inaudible 00:35:12] has a lot of affinity for Massapequa.

Michael Batnik (35:15):

I saw the news. I saw the news.

Brendan Ahern (35:17):

Yeah. Yeah. It was too bad. The little league team. But they did great. They did great.

Michael Batnik (35:21):

They did great. All right. Well, listen, Brendan, we appreciate your time. Thank you so much for coming on, being a friend of the show, and we appreciate it.

Brendan Ahern (35:27):

No. My pleasure. Thank you.

Ben Carlson (35:30):

Remember, check out KraneShares.com for all of their funds and sign up for Brendan's newsletter and send us an email at [email protected].