Why this education ETF has had a bad 2021 so far

Chinese politics is weighing on the performance of the country's online teaching firms. 

One of the worst-performing exchange-traded funds (ETFs) so far in 2021 has been the Rize Education Tech and Digital Learning ETF (LSE:LERN). Measured to 13 July, the ETF saw a loss of 28.9% in sterling terms. In comparison, the MSCI All-Country World Index returned 11.9%.

The Rize ETF aims to invest in a basket of companies that will potentially benefit from the increased adoption of digital learning technology. The requirement of many school pupils and universities to shift to online learning during the pandemic last year saw bullish sentiment around such companies.

It might be tempting to conclude that this year’s poor performance is due to the reopening and return of in-person learning in some parts of the world. While it is possible this is weighing on share prices of some holdings, the source of the ETF's performance can be found elsewhere: Chinese politics.  

According to the ETF’s latest factsheet, around one-quarter of the portfolio are Chinese companies. In recent years, China has experienced a boom in online private tutoring, largely due to the country’s hyper-competitive education system. Now, the Chinese government wants to rein this in.

According to reports, Chinese parents feel forced to spend ever increasing amounts on online private tutoring. These costs, the government supposedly fears, are discouraging couples from having children. Amid concerns about China’s ageing population, the government has launched a crackdown on such companies.

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This crackdown will include a ban on online and offline tutoring on weekends during term time. According to Reuters, it is estimated that these new rules could see tutoring companies lose as much as 80% of their revenue. And when expected revenues fall, so do share prices.

One such company is New Oriental Education & Technology Group Inc ADR (NYSE:EDU), one of China’s leading private education providers. This company currently accounts for around 6% of the ETF’s portfolio. Year-to-date, it is down by over 60%. Another example is TAL Education Group ADR (NYSE:TAL), which provides after-school education for students in China. The company is currently around 4% of the ETF’s portfolio and has lost almost 70% year-to-date.

China’s anti-tech crackdown

However, there has also been wider negative sentiment around Chinese tech stocks, and China’s leading online education firms have been caught up in this. One part of this anti-tech crackdown in China has been increased scrutiny by the Communist Party of China of companies that have listings abroad, particularly in the US. To get around Chinese laws around foreign investment, companies such as Alibaba (NYSE:BABA) and Tencent (SEHK:700) have used so-called Variable Interest Entities (VIE). This entails the Chinese company setting up an offshore entity, usually registered in the Cayman Islands. The shares in this entity are then sold on an exchange to foreign investors, skirting the restrictions.

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This arrangement has largely been tolerated by the Chinese authorities. However, the government now wants to start requiring firms going public in this way to first seek approval. This could also require existing firms with an offshore VIE structure to seek approval before issuing new shares.

This has created some uncertainty among investors about the longevity of Chinese companies listed on foreign exchanges. The two Chinese education companies in the portfolio mentioned above are both listed on the New York Stock Exchange and are therefore seen as potentially at risk too.