Playing Chinese Internet Stocks

 | Jan 16, 2014 | 9:30 AM EST
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When someone starts talking to you about investing in China, what's the first thing that comes to mind? I know -- that 60 Minutes piece from a few years ago about the "ghost cities." Then you think of the massive demand for commodities over the last 10 years that they've been using to build massive amounts of infrastructure --so much infrastructure that there's all this excess capacity' You think that excess is sure to be deflationary and prone to depression with feeble equity markets for years to come.

One thing I've learned in recent years is that our perspective as Americans on foreign markets is almost always wrong. For example: three or four years ago, Mexico was considered not a place to invest because of the drug violence. Well, the stock market went straight up and the drug violence turned out to be a 2009 story, and is declining. Or Africa is not a place to invest because it is Africa. People are going to be plenty sorry about that one.

China does have a command economy with central planning and five-year plans. I am certainly no central planner -- far from it -- but I will concede that a well-planned command economy can outperform an incompetently managed free market economy for quite a long period of time. We actually just passed a law here that makes it near impossible for new businesses to grow beyond 50 employees. That is senseless.

Let's look at the ghost cities again. China continues to move away from investment and towards consumption, and they are moving – literally -- hundreds of millions of people from the countryside to the cities. When my friends travel to China, the word they use to describe it is: mind-blowing. When these people arrive in the cities, they will be greeted by free public Wi-Fi networks. You guessed it -- internet and internet retailers are going to be huge in China.

The question, as is always the case in China, is how to play it. There is this perception that the A-shares of local companies are typically the best investments, and a lot of fund providers spend a lot of time trying to give people access to the A-share market. But you don't need access to the A-share market to trade China.

There is a small ETF outfit called KraneShares (KWEB) that has a few China-related products. One of which (that I own) is KWEB -- a basket of Chinese internet retailers. When you look inside the basket, you will find that there are mostly U.S. (and Hong Kong) listed companies inside of it, which is fine.

U.S. listings are better. Historically, big Chinese state-owned industrial companies were funded by debt. But the Chinese internet sector is going to be funded by equity and these companies are going to need access to U.S. markets.

KWEB is a new ETF, but it is trading briskly and there is plenty of liquidity. As the former head of ETF trading for Lehman Brothers, I can tell you about the gold rush that happened in ETFs during the last decade. It is, however, hard to get an ETF provider off the ground now. Nobody is willing to seed them, nobody has the marketing muscle to attract assets and it's the classic hen-egg problem where people won't trade them if there's no volume. But there's no volume because people don't trade them.

KWEB is one of those very rare success stories in the ETF world -- a product that solves a problem that people didn't even know they had -- how to invest in Chinese internet companies.

I'm bullish.

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