After an impressive rally that commenced in April and lasted for a good portion of May, Chinese internet equities and the KraneShares CSI China Internet ETF (KWEB) are in the midst of a pullback. Most analysts view this as health, but it could be a sign that KWEB and its holdings could be in for some sideways price action over the near-term.
If that’s the case, the KraneShares China Internet and Covered Call Strategy ETF (KLIP) could be an ETF to consider. In simple terms, KLIP is the covered call answer to KWEB. Both ETFs linked to the CSI Overseas China Internet Index.
Chinese internet stocks, including those in KWEB, typically aren’t yet dividend payers. The ones that are usually do so in nominal fashion. With its option-writing methodology, KLIP brings income to the Chinese internet equity party as highlighted by a jaw-dropping distribution rate of 44.33%, as of June 18.
Why KLIP Matters Now
Alone, KLIP’s distribution yield is enough to entice income-enthused investors, but there’s more to the story. Should Chinese internet stock prove lethargic or post small gains over the near-term, KLIP could be appealing.
“Generally, covered-call funds have performed well in flat to modestly bullish markets. If the option expires without being exercised, the seller keeps the stock and the premium received,” noted Emily Doak of Charles Schwab. “As a result, covered-call funds often report higher-than-average yields due to selling options and delivering the premiums along with dividends earned on stocks to investors.”
The rub with covered call ETFs is that if the underlying equity benchmark rallies, these funds will not capture all of that upside. On the side of the coin, KLIP can provide some downside protection when KWEB holdings trend lower.
“On the other hand, when the market drops, covered-call funds may perform less poorly than long-only strategies since income from selling options may help cushion some of the blow,” added Doak.
Another benefit of KLIP is that it could be an appropriate addition to tax-advantaged accounts, including IRAs. This is especially true for investors seeking emerging markets exposure or elevated levels of income.
“For investors who want the potential for higher income payouts from an equity fund, with additional income to cushion returns in down markets, but are willing to give up some potential upside in exchange for higher income, and who plan to hold the investment in tax-advantaged IRAs or other retirement accounts, a well-managed derivative income fund may be useful,” concluded Doak.
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