In November, 2018, at the inaugural China International Import Expo (CIIE), Xi Jinping gave a keynote address announcing the launch of a new “science and technology innovation board” at the Shanghai Stock Exchange. Just over two years later, the Sci-Tech Innovation Board, also known as the STAR market, has registered over 200 IPOs and raised more than $44 billion. The rapid growth of the exchange has been enabled by regulatory innovations: unlike other onshore equity markets, the STAR Board allows unprofitable companies to go public.
In 2020, the STAR market accounted for 47 percent of the capital raised across China’s A-Share market. Some of the largest and most well-known firms in the market include chipmakers Montage and Raytron, software developer Kingsoft, and autonomous-device manufacturer Roborock. As a technology-focused exchange, the Sci-Tech Board often registers companies that align with China’s strategic innovation policies, providing a tailwind to the market. In 2021, three of China's "four AI dragons" (AI四小龙)—Megvii, Yitu, and Cloudwalk—are expected to list on the exchange. Altogether, the Shanghai Stock Exchange plans to sponsor 233 IPOs in 2021, more than any other exchange in the world.
In January, 2021, Krane Funds Advisors, a U.S.-based asset management firm, launched the first STAR-50 ETF, KSTR, on the New York Stock Exchange. Through a combination of the firm’s 17 investment products, KraneShares manages over $5 billion in assets. In 2020, all of KraneShares equity funds saw positive returns (Figure 1).
During the week of March 7, 2021, the editorial team at China Tech Blog interviewed KraneShares’ Chief Investment Officer, Brendan Ahern, to learn more about his firm’s new STAR-50 ETF, KSTR, which tracks the performance of the 50 largest companies in the STAR market. As CIO, Mr. Ahern leads KraneShares’ research and client education efforts. He also authors a daily market update called China Last Night (www.chinalastnight.com), which appears as a column on Forbes.com. Below is a transcript of our email correspondence, which provides insight into the background of the STAR market and the potential opportunity it presents for investors.
1. Why did KraneShares decide to launch its STAR-50 ETF and what should investors know about the new market?
The Shanghai Stock Exchange’s STAR Board launched in June 2019 and has quickly become a leading venue for innovative companies in China to raise capital to fund their growth, research, and development. The rationale for the STAR Board’s launch is similar to why the Nasdaq was launched in the early 1970s. The Nasdaq bridged a gap for small, growth companies in the U.S. that would have otherwise had trouble accessing capital via an IPO due to prohibitive listing requirements and high fees. The STAR Board is doing the same thing in China today, as profitability listing requirements have kept many companies from listing in the past. Similar to Nasdaq’s early years, an investor should expect the market to be volatile and right size their investment accordingly.
2. Compared to KraneShares’ other popular products, such as the internet-focused KWEB fund and the large/mid-cap KBA fund, what is unique about KSTR? What distinct exposure does it provide to the China market?
KSTR provides exposure to mainland Chinese growth companies versus KWEB’s focus on Hong Kong and U.S.-listed internet companies and KBA’s exposure to MSCI’s definition of Chinese A-Shares. There is no stock overlap between KWEB, KBA, and KSTR. KSTR is unique for its A-Shares growth exposure with no financials, energy, industrials, nor materials sector stocks. For investors looking for New China stocks in the mainland, KSTR is uniquely positioned.
3. Why has the STAR market been such a popular venue for IPOs and do you expect this trend to continue?
The STAR Board appeals to companies that may not meet listing requirements such as profitability for the main boards of the Shanghai and Shenzhen Stock Exchanges. U.S. exchanges and Hong Kong have historically been the choice for such companies, but the STAR Board is quickly becoming a new competitor. Recently, a shortage of semiconductor chips has led Ford, GM, and Toyota to idle auto plants. There will be increased focus on companies securing semiconductor supply lines, which explains why we’ve seen several semiconductor manufacturers list on the STAR Board. We’ve also seen several companies aligned with China’s growing technology needs list on the STAR Board including software, AI, and cloud computing companies.
4. Some companies listed on the STAR market—but not included in KSTR—have been the target of U.S. sanctions and delistings. Is political risk something that international investors should be concerned about?
Like other global asset managers, we have adhered to the United States’ Executive Order. We watch CNH, China’s currency price during U.S. trading hours, as an indicator of whether headlines have any bite to them. While stocks may react negatively to such headlines intra-day, CNH has become a good tool for investors to stay committed to a long-term investment and not be shaken out by short-term noise. We believe potential cooperation on climate change offers an opportunity for mutual benefit between the U.S. and China, driven by the potential for John Kerry to play an outsized role in the Biden Administration. A small win on climate change could lead to better dialogue and communication, paving the way for further agreements.
5. What are your expectations for the performance of the STAR-50 and the broader China market over the next 12-18 months? Will growth stocks continue to lead the pack or is there a possibility that value could outperform during the global recovery from COVID-19?
We are constructive on Chinese equities as the new 14th Five-Year Plan provides transparency on economic sectors and the underlying companies that should benefit from supportive policies. STAR Board listed companies are aligned with many favored sectors including semiconductors, 5G, cleantech, biotech, and technology applications such as AI, big data, and cloud computing. Globally, growth stocks have outperformed, though we are seeing signs of a value/cyclical rally being driven by global reopenings and economic rebounds. Energy and materials have rebounded, driven by rising commodity prices, while a steeper U.S. yield curve could benefit banks globally. At the same time, China shows us that many growth companies such as e-commerce have come out of the pandemic in a stronger position. Amongst growth stocks, investors likely will differentiate between concept stocks—companies that hope to succeed—versus quality growth companies with revenues, net income, and strong cash flows. While growth sectors will have to share the stage with value sectors, I believe quality growth companies will maintain interest from investors.
Source: Getty Images
The STAR Market to the Moon?
2020 was a watershed year for the Sci-Tech Innovation Board. The total market capitalization of the STAR market grew nearly fivefold, reaching more than $500 billion through a combination of new equity issuance and capital appreciation. In 2021, the exchange is forecast to continue to dominate the onshore IPO market. Market agent estimates that the exchange will register between 150 and 180 new IPOs, raising a combined sum of between $40 and $50 billion. If achieved, the STAR market in 2021 will raise nearly half of what the Nasdaq raised in 2020—an exchange with nearly 50 more years of history and more than 40 times the average daily trading volume.
In 2021, the chip-heavy STAR market is poised to benefit from a rebound in cyclical growth. Although the Chinese government has set a modest growth target of 6 percent for 2021, the IMF predicts China’s economy to grow at a rate of closer to 8 percent. An uptick in enterprise digitization and consumer electronics consumption will provide a tailwind for semiconductor demand. China is already the world’s largest and fastest growing market for integrated circuits, and this trend is set to continue as the economy becomes evermore digitized.
Like all investments, investing in the STAR market does not come without risk. The new market is known for high volatility and, in 2020, the average market entrant rose over 180 percent on its first day of trading. This exuberance indicates the tendency for mispricing between IPO underwriters and the public market. In the long run, however, the STAR Board will gradually grow more liquid and more mature as new firms list on the exchange. In the process, the market will develop beyond its current state, as a hotbed for speculation, and assume its primary role: funding innovation in China’s real economy.
All opinions expressed in this essay represent my personal views only.