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US vs. China, battling for AI supremacy of the internet as best seen through the lens of ETFs
Published on 21 July 2023
Allan Lane
Allan Lane
Algo-Chain, Co-Founder
As the US and China battle for technology supremacy, in this week's newsletter, I thought it would be timely to look at this topic through the lens of two ETFs, specifically First Trust's Dow Jones Internet Index Fund and KraneShares' CSI China Internet ETF.

A retail broker once suggested to me that unlike stocks, ETFs were incredibly boring as there was no backstory to tell. Actually, it’s quite the opposite, as many ETFs often look to invest in the largest stocks in an index by market cap. On that basis looking at the top 10 holdings of an ETF provides a very quick way to familiarize oneself with a niche segment or industry.

Using an ETF’s top 10 holdings as a ‘Yellow Pages’ directory of who’s who

What's interesting about these two internet themed funds is that one tracks the US market whereas the other one tracks the top players in China. One of the lesser appreciated benefits that benchmark index providers bring to the table, is the wealth of knowledge and data that goes to make a benchmark. And we can benefit from that now by seeing which companies are dominating that industry.

Let's start with the US first by looking at an ETF that was launched in 2006 and looks to track the Dow Jones Internet Composite Index. This ETF was launched by First Trust who are a very well-established US fund manager, based in Illinois, managing over $200bn of assets. As we look at the top 10 holdings it is dominated by the big household names such as Amazon, Meta, Salesforce, Cisco and Netflix, amongst others. Would you be surprised if I told you that Salesforce is now promoting Einstein GPT, their answer to all things AI? What mystifies me though, is why such a giant in the tech space would have such a badly named chatbot. Is this complacency or just a complete lack of imagination?

Drilling down into the detailed analytics one can see that after the hard sell off that started in late 2021, and continued into most of last year, that sector has bounced back very strongly.
ETF tracking the Dow Jones Internet Composite Index
To get a handle on China's major tech firms let’s look at the KraneShares ETF as they are one of the ‘go to’ companies for all things China ETFs, having launched their first product some 10 years ago. The founder Jonathan Krane set up shop in Shanghai, knowing his firm would then have access to a lot of local knowledge giving it an edge over the competition.

Perhaps not surprisingly the top 10 holdings of that Internet ETF include names like Tencent Holdings, Alibaba and Baidu, which is exactly what we would expect from a fund providing exposure to the largest tech firms in China. In truth, calling all of these firms as ‘tech’ companies isn’t correct, whereas categorizing them as ecommerce firms might more accurately capture the Zeitgeist of today.
ETF tracking Chinese internet companies
As we look at the performance leading up to and after lockdown one sees that China's mega cap ecommerce firms have not yet bounced back in the same way that their US counterparts have. Was that because China was the last country out of lockdown or because of the crackdown on technology by the Chinese authorities?

Did ChatGPT drive the US’s tech rally and did politicians kill China’s rally?

The strength of the US tech rally has surprised many, me included. Was that a result of the mania that accompanied the launch of ChatGPT or is there something else afoot?

Over the last few weeks, I’ve heard the same repeated narrative that ChatGPT drove the rally in all things related to semiconductors, which in turn spurred on the hype for almost every corner of the tech eco-system. In which case, why has China not yet reacted to that same hype?

It’s not as if the topic of AI had suddenly arrived out of nowhere. If you think the obsession with AI began 6 months ago when ChatGPT exploded onto the scene, think again. It has been almost 5 years since Kai-Fu Lee wrote his excellent book entitled “AI Superpowers” which tells the story of how this topic became an engine of growth for both China and the US.
It has been almost 5 years since Kai Fu Lee wrote his excellent book entitled AI Superpowers
With a background that included being the President of Google China, holding executive positions at Microsoft, SGI, and Apple, along with an educational background that included a Computer Science degree from Columbia University and a doctorate from Carnegie Mellon University, when it comes to AI, Kai-Fu Lee speaks with firsthand experience.

Maybe the lack of AI hype coming from China reflects the fact that as a society, they are further ahead in the AI race than most Westerners realize. Not so long ago, the consensus was that China was lagging the US when it came to all things AI. However, based on the paper, “Is China Beating the U.S. to AI Supremacy?”, published by Graham Allison, The Douglas Dillon Professor of Government at Harvard Kennedy School and Eric Schmidt, the ex-CEO of Google, that naïve view appears to be well past its sell by date.

China and the US may well be at different stages of the recovery cycle, but it does feel they are both battling it out for AI supremacy.

At a very basic level of understanding one would expect the Chinese tech market to bounce back exactly the same way as the US market has, but the not so hidden political interference of both respective governments suggests all bets are off. During the last couple of years, we have watched one of the biggest trends in investing, namely ESG, get derailed by the influence of politicians, and it’s very likely going to be the case with AI & technology. In China, the authorities have clamped down on the way tech is used and that process appears to be well underway, whereas in the West it still feels as if the debate has only just started. In all likelihood, Europe will move quicker than the US in imposing more restrictions on the use of AI, much in the same way data protections laws, as represented via GDPR, have.

What makes the topics of both AI & ESG different, is the profound relevance and impact that these topics have already brought to many countries and countless individuals. Generally speaking, one thinks of ETFs as carrying far less idiosyncratic risk as compared to investing in single stocks. While that will always remain the case, the stakes are so high when talking about the rights and wrongs of climate change and AI, that whole industries will be impacted as all governments battle with these issues.

As an ETF investor, that makes for interesting times. When the fortunes of whole industries are at the behest of politicians then diversified tracker funds carry far more risk than they would have done otherwise.

Welcome to the ‘Real Politics’ of ETF investing.

Until next time.

Allan Lane