A Closer Look At China's Internet ETF

Bolstered by strong showings by Amazon.com, Inc. AMZN and Facebook Inc FB, U.S.-focused Internet exchange traded funds are among the top-performing industry funds this years.

The groups marquee names, the First Trust Dow Jones Internet Index Fund FDN and the PowerShares NASDAQ Internet Portfolio PNQI, are up an average of 16.1 percent this year, roughly double the returns offered by the Nasdaq Composite.

Things have not been as spectacular for China Internet ETFs. For example, the KraneShares CSI China Internet Fund KWEB's nearly 11 percent year-to-date gain is nice, but it pales in comparison to the returns offered by the aforementioned U.S. rivals FDN and PNQI. That does not mean investors should write off KWEB.

A Closer Look

KWEB, which recently celebrated its second anniversary, has developed a cult following in its two years of trading; China has more Internet users than the U.S. has population. Additionally, KWEB and rival ETFs are known for being home to companies that are considered to be the Amazons, Facebooks and Googles of China.

Related Link: How To Play China's 'Triple Bubble'

Those should be positives in KWEB's favor, but over the past three months, the ETF has slumped nearly 8 percent. FDN is up 8.3 percent over the same period and touched an all-time Wednesday. Still, there are potential catalysts for KWEB and its holdings that may not be fully appreciated at the moment.

“China’s desire to increase domestic consumption led Premier Li Keqiang to announce the Internet Plus strategy on March 5th at the 2015 National People’s Congress Session,” according to a KraneShares research note. “The new policy aims to drive economic growth by integrating internet technologies with traditional sectors and will focus on fostering new industries and business development, including ecommerce, industrial internet, and internet finance.”

Additionally, MSCI, the index provider for scores of widely followed international benchmarks, said earlier this year it will begin including Chinese companies that do not have primary listings in Hong Kong, Shanghai or Shenzhen in its international indexes. That means after years of being excluded, companies such as Alibaba Group Holding Ltd BABA and Baidu Inc (ADR) BIDU will start appearing in China and emerging markets ETFs that track MSCI indexes in early December.

“Currently, the total N-share market cap is $487 billion,” said KraneShares. “The change in index composition will cause a total of $70 billion to be reallocated to U.S.-listed Chinese companies, which will increase the N-share market cap by 14%.”

Alibaba and Baidu are KWEB's second- and fourth-largest holdings, respectively, combining for 17 percent of the ETF's weight.

Mobile Internet use is another massive opportunity for KWEB constituents, including the ETF's largest holding, Tencent TCEHY. China has 10.7 percent of the world's cell phone users and Tencents WeChat platform, which is focused on providing Internet and mobile services, has nearly 550 million active users, according to KraneShares.