vm By Alex Rosen Strategy KraneShares MSCI China Environment Index ETF (NYSEARCA:KGRN) invests in Chinese companies, unrestricted by size, that derive 50% of their revenue from green technology. The fund focuses on the following areas: Alternative energy, energy efficiency, sustainable water, green building, and pollution prevention. Holdings are capped at 10%, and all securities with a more than 5% share are limited to 40% of the total fund holdings. Fund selection is based on data from MSCI Environment, Social, and Governance. The index is rebalanced quarterly. Proprietary ETF Grades Offense/Defense: Offense Segment: Commodities Sub-Segment: Carbon Risk (vs. S&P 500): High Proprietary Technical Ratings Short-Term (next 3 months): Hold Long-Term (next 12 months): Hold Holding Analysis KGRN tracks the MSCI China IMI Environment 10/40 Index. The index has a tight selection of 35 individual stocks, with no one holding allowed to exceed 10% of the entire portfolio. The top holdings by sector are consumer discretionary (38%), industrials (31%), IT (14%) and utilities (12.6%). The fund holdings are split between Hong Kong, and Mainland China. The fund has a surprisingly high expense ratio of .78%. The top individual holdings include Li Auto Inc. (10%), a leader in the manufacturing of electric cars in China, Contemporary A-A (9%), a leader in the Chinese battery industry, NIO Inc. (8%), another Chinese E-car manufacturer, and BYD Co. (8%), an e-car company. Strengths Talking about China is like talking about the poker player with the largest stack of chips at the table. By sheer brute strength, they can force other players to drop out of a sector, or dominate the direction in which it goes. When China committed to investing in renewables, they almost overnight became the global leader. Today Chinese investment in renewables accounts for 43% of the $226 billion global market. In addition to this, China is by far the global leader in coal consumption, burning 4x as much as the number two country, India, meaning they have plenty of room for growth. China dominates the world coal consumption (world population review) The commitment to growth is there. The Chinese government expects that by 2025, more than 1/3 of all energy produced in China will come from renewable sources. China is the global leader in solar energy and the largest producer of wind turbines. Make no mistake, China has pushed its massive pile of chips all in on the green economy. However like any good gambler, they do this with the expectation that the payoff will be extremely high. China isn’t in it just for the environment. They expect a very high ROI. Weaknesses China’s full throttled commitment to renewables has made them the world’s leader in consumption of the raw materials needed for the development of the technology. In fact, they have completely disrupted the supply chains and limited the world’s ability to expand the green sector based on existing technology. Essentially, until this is resolved, China has created a cap on growth. Chinese ambition has seemingly outstripped capacity. As we have seen in the past few years, the global economy is very fragile and supply chain issues have an overwhelming effect on growth. Unlike the oil and gas sectors which are well established and not high on innovation, the renewable sector is really subject to the whims of R&D. New technologies have shown how the potential for growth is there, but without an established infrastructure, and consistent access to critical resources, that potential is really limited. Opportunities The market is stuck in neutral at best. KGRN is down 31% over the past twelve months. The underlying holdings have really been hit hard by the global slowdown. However, this is not a passing fad fund. The world cannot stick its head in the sand and ignore the reality on the ground. The future of energy is renewable, and the sooner we get there, the better everyone and everything is. Geopolitical events like the war in Ukraine have reminded people just how crucial it is to make sure we wean ourselves off of non-renewable energy sources. Additionally, the health risks associated with the continual burning of fossil fuels has made it that much more important that the shift to renewables be fast tracked. Threats Existing technologies rely heavily on rare earth metals and specialized manufacturing processes that are currently limited by externalities. Presently, renewables lack the capacity to fully meet demand, and have started to reach the peak of what they can provide. Greater investments in R&D and infrastructure are needed before the sector can break through its ceiling and really become a factor. KGRN’s investment in the companies that make the world green is really an investment in the Chinese government and its commitment to the green revolution. Today China is committed, but tomorrow they may decide that its cheaper to simply build a new Beijing than to solve the fossil fuel issues as the city is being choked by pollution. Conclusions ETF Quality Opinion As mentioned before, investing in a China fund is really an investment in China as a country. The largest stack doesn’t always win in poker, but the betting odds sure do like them. KGRN has focused on a select concentration of companies in China and has pushed all of its chips into that bet. While we don’t like the expense ratio, we do think the model is sound. ETF Investment Opinion Renewable energy is not just the future, but also the present. The sector can’t afford to fail, and China knows that. The real difference maker is China’s ability to grow the sector. While it is currently experiencing growing pains due to supply issues, long term we see this as a winner. For the time being we rate KGRN a Hold until those issues are resolved.
