JPMorgan’s callable income notes on KraneShares ETF offer deep value, contrarian says

By Emma Trincal

New York, Feb. 2 – JPMorgan Chase Financial Co. LLC’s 0% callable contingent interest notes due Feb 5, 2026 linked to the KraneShares CSI China Internet ETF offer an attractive return with a lower level of risk given the undervalued price of the underlying, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

“This is a pretty compelling note,” he said.

The notes will pay a contingent interest payment at the rate of 15% per year if the ETF closes at or above the interest barrier level, 72% of the initial level, on a quarterly review date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes may be called at par plus any coupon due on any quarterly review date after six months.

If the notes are not called, the payout at maturity will be par unless the ETF finishes below its 72% trigger level, in which case investors will lose 1% for every 1% decline of the ETF from its initial price.

“This note is done on a deeply discounted asset. It stacks the odds in your favor. You also have some downside protection, which makes the investment even less likely to lose money,” he said.

PEG ratio

KraneShares CSI China Internet ETF tracks China-based companies focused on internet and internet-related technology.

Kaplan pointed to an indicator widely used by value investors: the price/earnings-to-growth, or PEG ratio.

The ratio provides information on the valuation of a company in relation to its profit growth.

“A PEG of 1 means that the stock is fairly valued. Its price is in synch with its profit growth,” he said.

“When the PEG is less than 1, which is the case with KWEB, then the security is undervalued.

“The lower the PEG, the more undervalued it is.”

The underlying ETF trades on the NYSE Arca under the ticker “KWEB.”

The share price of the KraneShares CSI China Internet fund peaked on February 2021 to $104.94. At that time, the PEG was 3.25, he noted.

Then the ETF share price bottomed on October 2022 at $17.22 showing a PEG ratio of approximately 0.5.

From the October 2022 low to January 2023, the share price more than doubled. The PEG went above 1 at that point.

Undervalued

“It’s not that the profitability of the company had changed during those three months. It was just a change in sentiment. People began to pay attention to the low valuation of the ETF,” he said.

“A price that’s undervalued or overvalued by the market always ends up going back in line. History proves it. If the price drops too much, it eventually bounces back. If it’s too high, it will go back down.”

The ETF on Friday afternoon closed at $23.11 a share.

The current PEG ratio is 0.7.

“It’s not as cheap as it was in October 2022. But it’s still very low,” he said.

“Compare the PEG of this ETF with other tech companies especially in the U.S. and it’s clear that KWEB is a bargain.”

Apple for instance has a PEG ratio of 4.7.

“Apple is extremely overvalued. The fact that it’s trading at such a high price means that people do not pay attention to value. They just want to chase returns; they buy overvalued companies without paying attention to risk,” he said.

The KraneShares CSI China Internet ETF offers the opposite picture.

“The constituents of KWEB have strong growth rates, which are not reflected in the share price,” he said.

“This disconnect is an indicator of true value. It shows whether an investment is worthwhile.”

Margin of safety

The note, which offers direct exposure to the ETF with a potential return of 15% a year and a contingent downside protection of 28%, was attractive, according to this portfolio manager.

“When you buy a depressed asset that has been going down for three years by large percentages while profits have been going up, it gives you a significant margin of safety,” he said.

“In the long run, the price will reflect the intrinsic value of a company, and its real growth prospects. It may take time but your chances of losing money are much lower when you buy a stock at a discount than when you buy it at a high price.”

Two years

The key word however was “in the long run.” Value investing often requires patience and the tenor of the notes was only two years. Would that be enough time for a reversal?

Kaplan said that the price did not need to rebound. Both the structure and the ETF’s low valuation increased the odds of winning despite the short investment timeframe.

“The way the note is structured, you don’t even need a price gain. You need a rebound if you’re long the position. Here you just need not go down too much. As long as the share price doesn’t drop more than 28% you get paid,” he said.

“With the fair value right now so much above the current price, you are very unlikely to see such a big drop in the share price even in two years.”

It’s not political

Kaplan downplayed the impact of geopolitics as a factor behind the low valuation of the Chinese ETF or its unpopularity.

“The price is low because people don’t want to buy an asset that keeps on falling. When the price drops, they sell.

“The market is driven by momentum. Even hedge funds, which are supposed to do things differently, are net short KWEB at the moment. But there will be a reversal at some point.

“And if the price starts to move up, everybody will jump on the bandwagon and pile into KWEB regardless of how they feel about China,” he said.

Issuer call

Another feature – the issuer call – was worth considering as well prior to investing.

For Kaplan, the discretionary call was not a problem since the notes are called at par.

“You may or may not be called away. But if you are, you’re not going to lose anything,” he said.

The call may even help investors get better outcomes by not making investment decisions on their own, he added.

“It’s unlikely that [the issuer] would call if the position lost money. They’re more likely to call if the price is high. That’s a great thing. It gives you the opportunity to sell at the right time, even though it’s not really your own decision,” he said.

Whether automatic or discretionary, the call can replace a discipline few investors are capable of implementing on their own, which is to sell when the price is up, he explained.

“I think it’s a great thing. You get your money back with your coupon. That’s exactly what you want,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes were set to price on Feb. 2 and to settle on Feb. 7.

The Cusip number is 48134T4L5.

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