Jay:  Brendan, thanks so much for joining us. Who better to have on than the leading provider of China-focused ETFs, KraneShares? Thank you for joining us. Maybe you could give a quick introduction to the audience tuning in — who you are, what you do for a living, and what KraneShares is.

Brendan:  Very much appreciate this opportunity, Jay. KraneShares is a China-focused provider of exchange traded funds. I had spent 13 years with the largest provider of exchange traded funds globally. So the vast majority of my career has been spent in the indexing and passive space, particularly around ETFs.

About four and a half years ago, I met John Krane and joined John as he started building KraneShares, really based on his vision, having lived in China which was, one, that China was opening up its capital markets, the onshore markets, to foreign investors and, secondarily, that new China sectors were underway in traditional indices.

So I brought my skillset from the ETF world and applied that to John’s vision in producing our suite of exchange traded funds.

Jay:  That’s fantastic. As a brief background, I started doing ETFs in 2001 to 2003. I was working at Lehman Brothers at the time. I guess ETFs kind of just started picking up the growth in the early 2000s. I think they started in the early ’90s, but it was right around the time when a lot of institutional clients were starting to get “Oh, this is interesting. There is another source of liquidity.” Interesting that you’ve been in that segment for a long time.

I really like the fact that you guys are China-focused, obviously. I think that there is a need and a thirst for ways to play China. So maybe you could explain how KraneShares differs from an FXI or some of the other more popular ETFs out there.

Brendan:  One, the historical definition of China has been Chinese companies listed in Hong Kong. One, we recognize that you have Shanghai and Shenzhen, the fourth and seventh largest stock exchanges globally by market capitalization and very limited exposure in investors’ portfolios because they’ve been ring-fenced from foreign investors, but we saw that that door was opening and wanted to skate to where the puck was going, establish products in advance of their inclusion within broader indices.

Over three years ago, we listed our MSCI China A international EFT, KBA which utilizes RQfi, and now we’re starting the access the onshore market via the connect trading. The MSCI China A international is the exact definition of Shanghai/Shenzhen now will be going into broader MSCI indices. To me, MSCI is the most important financial firm globally. Their global investable market index methodology is just over 170 pages long, but it dictates how over 10 trillion of both active and passive assets are invested, and very few investors have really read that methodology.

But the reality is, just using MSCI emerging markets which has 2 trillion benchmarks against it, MSCI China A international will represent another 17% of that index being dedicated to China from 28%.

If we know 17% of 2 trillion, we’re talking about perhaps billions or tens be billions, but literally hundreds of billions of dollars that, in the case of the index funds and ETFs, are going to have to buy the securities that we hold today within our ETF KBA.

So a lot of it is applying my background in index methodologies and understanding how important those are in creating our ETFs including KBA.

Jay:  Did the MSCI give any sort of timeline, guidance on when they plan to implement that increase in waiting?

Brendan:  We don’t know the exact roadmap, Jay. We know that it will begin on May 31st of 2018. It starts small and just under 1%. We don’t know if they’ll add quarterly or semi-annually, but for investors, it’s important to recognize these country inclusions are very, very rare. In 2013, MSCI added Qatar and the United Arab Emirates. Last year they announced the inclusion of Pakistan. And in the one year preceding from the announcements to the actual inclusion, those markets tend to have historically performed quite well. So we think it’s a very additive strategy to get in front of.

What’s different about this inclusion is, yes, it starts small, and many have been very dismissive saying, “Well, it’s less than 1%.” But in the case of UAE and Qatar, they went up 40 and 80%. In the case of Pakistan, it went up just over 40%. So those are rounding errors compared to what’s going to be happening with the onshore Chinese equity market. It’s going to from just under 1% up to 17%. So there’s never been an inclusion like this historically.

Jay:  That’s incredible. Talk about a tailwind to get in front of for any investor. Even if you don’t know anything about investing and this seems like a very rare and unique once-in-a-lifetime trade that you can actually participate in, and now, thanks to KraneShares, it’s very easy to participate in this trade.

With that as the backdrop, let’s talk about what’s going on in China and why it’s so exciting and why your founder, being on the ground there and having spent many years there, decided that it was such a compelling shift that’s happening right now that he wanted to create the ETF. I think there is a lot of common misperceptions with China, especially with Western investors. There is a cognitive bias called home-country bias. I’m American. I’ve been over here for a while. That’s not just an American thing. People in Hong Kong, they only like to trade Hong Kong shares. It happens globally. But what are some of the biases and misunderstandings that you’ve encountered from investors, specifically with regard to China that maybe has shied them away from investing?

Brendan:  I believe our single greatest value-add, besides creating unique ETFs, has been our balanced perspective on China’s economy and capital markets. Yes, the media tends to highlight some of the liabilities.

Our view is if you’re going to talk about the liabilities, that means it’s a balance sheet. And if it’s a balance sheet, then what are the assets? Yes, say debt-to-GDP gets a lot of attention, but does anyone talk about bank-deposits-to-GDP? What if the bank assets and bank deposits in China are almost exactly the same as the debt-to-GDP? It’s not necessarily a problem.

I think we continuously put out research to provide that balanced perspective.

I think what people miss is that when John lived in China, he saw how people were migrating to these new-China sectors — healthcare, internet, e-commerce, technology, clean energy. People were migrating away from many traditional economic sectors.

It’s funny, Jay, when you look at the manufacturing PMI, you have 33 economists globally giving an estimate on what they think China’s manufacturing PMI will be. The non-manufacturing PMI, there is zero economists giving an estimate. Not one. I’ve actually tried to submit an estimate just to show that many parts of the world think that China is purely a manufacturing, export-driven dependent country. And yet today, 58% of China’s economy is driven by the service sector. Yes, we get retail sales numbers from the National Bureau of Statistics, which have between 10 and 11% on a monthly basis, but we really think a lot about the companies that are the transmission engine for domestic consumption in China that is leap-frogging over the big-box retailer stage, and it’s happening online.

What you can do on WeChat, a product of Tencent with a mere 900 million users on a monthly basis, you can’t do on Facebook here in the United States. China, in many ways, is far ahead of the adoption of internet and e-commerce than in Europe, Japan, or in the United States. We love that domestic consumption story as under-owned and misunderstood by many foreign investors.

Jay:  Absolutely. Brendan, you bring up a good point. Obviously, anyone that follows China or Asia knows about this rising middle-class theme. I was talking to someone yesterday who had written a book on e-commerce in China, and he was saying that 2025 was the backstop on the timeline between when the Chinese consumption as a percentage of GDP was basically going to go from the mid-20s percent to double that. And that’s all because of this rising middle class, online consumers. And the age demographic is quite specific as well — 20s, 30s. They’re going to have so much purchasing power.

That’s very interesting and exciting in addition to, obviously, the tech that has to be associated with that, the infrastructure that has to be associated with that.

One of the cool things that you guys do, you have at least one or two funds that are quite tech-focused, and there are a number of Chinese companies that are listed outside of China on Nasdaq, for example, that are not included in any other ETFs out there, so it’s hard to get exposure on a broad base, but you guys have figured out to include that into your ETF. So why don’t you talk a little bit on that?

Brendan:  Every day, Jay, we read about the growth of exchange traded funds, and yet I go back to this. Do people really understand these index methodologies? In the case of the largest emerging market ETF globally, it’s based on FTSE Russell indices. If FTSE Russell indices currently, if you’re listed outside of the country, you’re not part. So it’s not just an… Alibaba listed here in the United States isn’t part of FTSE Russell indices or ctrip or Netease or Sina, etc., it’s also a company like Prada. Prada is listed in Hong Kong. It’s not considered an Italian company according to FTSE Russell. So you literally have the largest EM, emerging market ETF globally doesn’t hold the names that… Over four years ago, we created the KraneShares CSI China Internet ETF. We listed that fund over four years ago because we knew what was taking place in terms of the rise of domestic consumption taking place online.

And just recently, FTSE Russell announced that they’re going to start adding. It will take place over the next two years, but they’re going to start adding US-listed Chinese companies to their indices. So, again, it’s getting in front of these flows by owning what others are going to have to buy. We think it’s an additive strategy as we exit the earning season for our portfolio. You just cannot find companies like Tencent and Alibaba, TAL Education, JD, you cannot find these rates of growth globally, in our opinion, highly biased and self-serving. But I definitely believe that this is the fastest-growing part of capital markets globally, and we think it really warrants a standalone position because you really can’t find companies this big growing as quickly.

Jay:  Tencent is one of those companies that I’m sure you’ve followed it just as long as I have, for a decade. Every time I’m like “Okay, this might be a good time to get in.” And you miss it, and you just keep watching it going away. But conceptually and in theory, if you think about what you were saying, that mobile technology has surpassed the West, people don’t even carry wallets anymore in China. It’s all on the phone. If you put the numbers together, some of the numbers that you were talking about and the fund flow, literally, there is only one direction that those companies are going to go. So that’s really exciting. And now we have a way to put it.

How many different China-focused ETFs do you guys have now?

Brendan:  We have five ETFs in total. I talk about our China internet. KWEB is the ticker. And KBA is our MSCI China A. We do have a New China. It’s a smart beta. It’s actually the only ETF globally that holds stocks on Shanghai, Hong Kong, New York, and Nasdaq. It’s a neat little fund.

We have a bond fund, China’s bond market, the interbank bond market is the third-largest bond market globally. Bloomberg Barclays global aggregate stole Lehman global aggregate. We’re dating ourselves here, Jay.

Jay:  I know.

Brendan:  But the old Lehman global aggregate doesn’t include the third-largest bond market globally. And it’s not the JP EM debt, Citi Sovereign as well. We’ll be back talking about the inclusion of the third-largest bond market into global indices, and then we have EM Plus, and it’s basically an EM and that already includes the Chinese A shares that we hold in KBA.

We’re continuously working on new product. We’ll be listing products in the months to come.

Jay:  That’s really exciting. Just one thing about ETFs and I know that on the institutional side, when we look at ETFs, one of the things that we look for and consider always is the liquidity. There are tons of ETFs that come online, and there is a distribution. It’s like the top five have the most liquidity, and then it drops off. How have you found KraneShares’ liquidity? Has that been an issue? What are they trading like each day?

Brendan:  I think the on-screen volume is important. I think for institutional investors, in many cases, they’re beholden to the largest ETFs simply because maybe they’re not allowed to be more than 20% of the assets, The Volker Rule actually requires some financial institutions, they can’t hold. Many hedge funds want to trade anonymously, and so they can only buy and sell in these liquidity, high, high volume.

But for most investors, can broaden their horizons beyond the 10 or 20 largest ETFs. You as an individual have a real advantage to be able to buy and sell something that many of these institutional investors, because they have these self-imposed or regulatory constraints, can’t buy.

What is important for any ETF is that the underlying basket of securities is liquid. In creating our products, we’ve built in liquidity screens. Most of the major index providers, knowing that ETFs make those indices investable and create some sort of liquidity screen, and then we as a provider add on our own screen as with.

I actually believe that as much as ETFs have grown enormously, as part of a business that in 2001 had basically no assets to 13 years later had over 800 billion and today has over a trillion in assets, very few people do ETF due diligence. And that’s why I believe we’re still in the early days of ETFs. You’ve got to have great, great funds that maybe don’t have high levels of assets.

Jay:  Very exciting. Brendan, thanks so much for sharing that. I think we gave a really good backdrop to the audience not only on the exciting trends that are happening in China but also a little bit on just ETF and fund flow perspective. If you put those two together and do the math, it’s just a massive, massive tailwind. And it’s still early, like you said. This is a very, very good opportunity to get on the trade. And also, KraneShares is the perfect way for an investor to get in.

I know you guys put out a lot of good research on your website for free, which is a great resource — I would encourage all of the audience members to follow that blog — where else can investors find a little bit more about you as an individual or maybe something of the offerings that KraneShares is coming up with?

Brendan:  That means a lot to me, Jay, coming from you. So complimentary. Right on KraneShares.com, you can sign up for free for this balanced perspective on what we see taking place and provide timely updates about every two weeks.

Jay:  Awesome. We’re looking forward to seeing what new products you guys come online with. We’ll certainly be catching up with you from time to time to discuss this massive shift that’s happening in China. We appreciate your time, Brendan. We’ll talk soon.

Brendan:  Thank you very much, Jay.

Jay:  Alright, take care.