alphabetaserieschinaindepth 41p]

8/6/2019 AlphaBetaSeriesChinaIndepth 41p]

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Alpha/Beta Series

China In-DepthJune 23, 2PM EST

Sponsored by:


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Todays Webinar: Alpha/Beta

Burton Malkiel

Professor of Economics

Princeton University

Chief Investment Officer

AlphaShares

The case for (and against) ChinaHow to get China exposure through ETFs

Dave Nadig

Director of Research

IndexUniverse


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Burton G. MalkielChairman of the AlphaShares Index Committee,

Professor of Economics at Princeton University

and the author ofA Random Walk Down Wall Street

Alpha/Beta Series: China In-depth

Webinar, June 23, 2011


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1

820

1

870

1

900

1

913

1

950

1

955

1

960

1

965

1

970

1

975

1

980

1

985

1

990

1

995

2

000

2

003

2

008

2

010

2

014

35%

30%

25%

20%

15%

10%

5%

0%

*Adjusted for purchasing power parity Source: Historical Statistics for the World Economy Angus Maddison, ISI.

Chinas GDP as a Percent of World total

China Was the Worlds Largest Economy

1820 China Was the Largest World Economy

1839 - 1860 Opium Wars begin Century of Humiliation

1949 - 1976 Maos Great Leap Forward and Cultural Revolution

1980 The Economic Revolution of Deng Xiaoping begins

Opium

Wars

Mao

DengJapan

4


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The Chinese economic revolution capitalism

is reintroduced to China

5

Purchasing-Power-Parity Valuation in Current US Dollars; Source: IMF

,0

500,0

1000,0

1500,0

2000,0

2500,0

3000,0

3500,0

4000,0

4500,0

5000,0

5500,0

6000,0

6500,0

7000,0

7500,0

8000,0

8500,0

9000,0

9500,0

10000,0

U.S.

$

Billions

Chinas Gross Domestic Product1980-2010

Purchasing-Power-Parity Valuation in Current US Dollars; Source: IMF


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Why China will continue to grow

1. Center and West are Undeveloped

- Hundreds of millions educated potential workers- Government policy designed to promote growth

2. Strong Balance Sheet- Over $3 trillion of reserves- Low government and personal debt/GDP

3. Effective Monetary Policy- Chinese banks in better shape than U.S. banks- Bank lending can be adjusted rapidly

4. Effective Fiscal Policy- Spending concentrating on needed infrastructure including the development andurbanization of middle and western regions (railroads, mass transit, etc.)

- Universal health care (social safety net) will stimulate consumption

5. Rise of Chinese consumer- Consumption is 1/3 of GDP in China vs. 70% in U.S.

6


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China will be the largest economy in the world again

soon

Source: Goldman Sachs

The End of the Age of America

Share of World GDP (Purchasing Power Parity)

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

25%

20

15

10

5

Data: International Monetary Fund, April 2011

7


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Three Prominent China Bears

Chanos: China is the new Enron

Dubai times 1,000

On a treadmill to hell

Chancellor (GMO): China exhibits characteristics of a great speculative mania

Rampant credit growth, overinvestment, excess capacity,asset price bubbles

China, a field of dreams, is in for a rude awakening

Faber: A crash is likely in the next 9 to 12 months

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The major arguments of the China bears

1. Overinvestment Has Led to Enormous Overcapacity

2. Massive Increases in Bank Lending Have Produced Asset

Price Bubbles and will Lead to a Financial Crisis

3. The Chinese Economy is unstable, unbalanced, and

unsustainable (Premier Wen Jiabao)

9


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10

The Bear Case: overinvestment and overcapacity

Overcapacity in steel, shipbuilding, cement, etc.

Diminishing returns on investment

Overbuilding of infrastructure

Ghost town of Ordos in Mongolia

Highways, railways, and bridges to nowhere

Source: Andrew Hunt Economics As of 12/31/09

80%

70%

60%

50%

40%

30%

20%

10%

0%

1980 1984 1988 1992 1996 2000 2004 2008 2010

Investment/GDP


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11

The Bull Case: investment and capacity will

be justified

o High growth economies inevitably have temporary excess capacity

but also high absorption

o 20 percent excess capacity in a 10% growth economy less

problematic than the same excess in a 2% growth economy

o Major part of investment went infrastructure

Will allow accelerated business expansion and relation to inland China Will help to more evenly distribute income

Will ultimately support faster consumption growth


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12

The Bear Case: massive credit expansion will

produce asset price bubble and financial collapse

o Massive credit expansion has produced bubbles in asset prices In 2009, the money supply grew by nearly 30%

Bank lending increased by RMB 10 trillion (almost 30% of GDP)

Invariably, such rampant increases in credit create asset price

bubbles- In property

- In stock prices

o Such credit expansion will ultimately increase NPLs and risk a

credit crisis


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13

The Bull Case: the 2009 credit expansion

will not lead to instability

o Government authorities began to slow lending growth in late 2009

reserve requirements

leverage limits interest rates

o Even if there is a property bubble in some areas it will not be asdamaging as in the U.S.

Asset-price bubbles are particularly dangerous when debt is high. Muchless leverage exists in the Chinese property markets

40% minimum down payments are required for property purchases

o Chinese consumers less leveraged than US consumers US: Debt/DPI = 130% US Debt/GDP 90% China: Debt/DPI = 34% China Debt/GDP 17%

o Chinese banks in much better shape than U.S. banks NPLs low If NPLs get out of hand government can inject funds Explicit government debt plus implicit debt of banks low relative to GDP

o Chinese equities are reasonably priced.


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Source: Bloomberg as of 12/31/2010

Index P/E P/E2011 Est. PEG P/B P/S Yield

AlphaShares China All Cap (YAO) 21.89 15.08 1.22 4.45 4.86 1.69

AlphaShares China Small Cap (HAO) 18.95 13.26 0.72 2.63 3.81 1.54

AlphaShares China Real Estate (TAO) 10.17 14.98 0.88 1.32 7.36 2.22

CSI 300 Index (A Shares) 36.94 19.11 NA 4.73 3.88 1.07

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Chinese equities are not priced at bubble levels


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The Bear Case: Chinas growth has been

unbalanced and unsustainable

o The Pillars of growth have been exports and investment

o Export growth can not continue to be so robust in a world

suffering from substantial unemployment currency frictions

protectionism

o Returns on investment will continue to decline


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16

The Bull Case: consumptions share of GDP

can and will grow

o Consumption now 1/3 of GDP

o Part of stimulus plan was to create the beginning of a

social safety net

o Tax policy can stimulate consumption

o Emphasis can be placed on the inadequate service sector

(Stephen Roach)

IT enabled service clusters centered on Chinas rapidlyimproving educational institutions

- software design, medical technologies, consulting, finance, etc.

labor-intensive growth would help absorb unemployment and

encourage consumption


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Some Recent Worries

o Hard Landing Reaction to uptick in inflation Inflation largely food and fuel- may have peaked

Growth slows only slightly

More pressure to let Yuan (RMB) appreciate

o Recent negative publicity concerning accounting irregularities Most of the problems involved reverse mergers

o Unrest: A Jasmine Revolution? Wall Street Journal Headline 6/14/11 Wave of Unrest Rocks China

Growth has lifted hundreds of million out of poverty and growth will continue 80 million members of Communist Party

Internal security a priority

17


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Big Mac Index


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Conclusions

China is not without problems

But a collapse is unlikely event some real estate markets areoverextended

Growth will inevitably slow but will continue at high single digit ratesfor at least another decade


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Chinese Beta: Problematic

Dave Nadig

Director of ResearchIndexUniverse


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The China Problem

Size


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Free Float AdjustmentDifferent Shareholders, Different Rules

Strategic Shareholders Non-Strategic Shareholders

Governments Individuals

Companies Pooled vehicles (ETFs/Funds)

Banks Security brokers

Principal officers/board Pension funds

Employees Insurance companies

Social security funds


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ACWI vs. GDP

2%

9%

0%

10%20%

30%

40%

50%

60%

70%

80%

90%

100%

ACWI GDP (US$ Billions)

Other

Brazil

China

Switzerland

AustraliaGermany

France

Canada

Japan

UK

US


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ACWI vs. GDP

Country Market-capWeighted

GDPWeighted

Weight Difference(GDP-Market Cap)

China 2.39% 9.26% 6.87%

Germany 2.95% 6.31% 3.36%

Italy 1.08% 3.99% 2.91%Russia 0.83% 2.32% 1.49%

Spain 1.31% 2.75% 1.44%

India 1.00% 2.42% 1.42%

Switzerland 2.93% 0.93% -2.01%

Canada 4.57% 2.52% -2.05%

United Kingdom 8.11% 4.10% -4.01%

United States 44.39% 26.76% -17.63%


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The Case for China Overweight:Emerging Markets Exposure

17.5%

37%

0%

10%

20%

30%

40%

50%60%

70%

80%

90%100%

EEM GDP (US$ Billions)

Other

India

RussiaSouth Africa

Taiwan

South Korea

Brazil

China & Hong Kong


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The China Problem

Shares


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The A-Shares Problem

Most indexes/ETFs do not include A-Shares

Of the top 100 in the CSI 300, 2/3 have nothing but A-Shares

75

100125

150

175

200

225

J-yy J-yy J-yy J-yy J-yy J-yy

A-H Premium Index


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The US Listing Problem


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Overview of China Equity ETFs

Broadmarket Funds Sector Funds

FCA First Trust China AlphaDex CHIM Global X China Materials

FCHI iShares FTSE China (Hong Kong Listed) CHIB Global X China Technology

FXI iShares FTSE/Xinhua China 25 CHIE Global X China Energy

GXC SPDR S&P China CHII Global X China Industrials

MCHI iShares MSCI China CHIQ Global X China Consumer

PEK Market Vectors China CHIX Global X China Financials

PGJPowerShares Golden Dragon Halter USX China

PortfolioCHXX EGShares INDXX China Infrastructure

YAO Guggenheim China All-Cap CQQQ Guggenheim China Technology

TAO Guggenheim China Real Estate

ECNS iShares MSCI China Small Cap

HAO Guggenheim China Small Cap


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5 More ETFs

Other Inverse & Leveraged Funds

FXP ProShares UltraShort FTSE/Xinhua China 25 Inverse

YXI ProShares Short FTSE/Xinhua China 25 Inverse

CZI Direxion Daily China Bear 3X Inverse

XPP ProShares Ultra FTSE/Xinhua China 25 Leveraged

CZM Direxion Daily China Bull 3X Leveraged

Other Currency

CNY Market Vectors Chinese Renminbi/USD ETN Currency

CYB WisdomTree Dreyfus Chinese Yuan Currency


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China Total Market: Sectors

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FXI GXC YAO PGJ PEK MCHI

Utilities

Information Technology

Health Care

Consumer Staples

Consumer Discretionary

Materials

Industrials

Telecommunication Services

Energy

Financials


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China Total Market ComparisonBasic Stats

AUM ($,M) Expense Ratio

AVG 30D Volume

(Shares)

FXI 7,552.49 0.72 15,763,100

GXC 746.08 0.61 86,394

PGJ 414.34 0.70 91,254

YAO 100.70 0.70 14,890

MCHI 28.75 0.61 8,731

PEK 18.87 0.72 6,256


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China Total Market Comparison

-20%

-10%

0%

10%

20%

10/19/yyyy 6/22/yyyy

FXI YAO GXC PGJ


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Bear Market Performance

-75%

-50%

-25%

0%

25%

10/10/yyyy 3/9/yyyy

S&P China BMI

FTSE China 25

AlphaShares China Allcap


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Bull Market Performance

0%

25%

50%

75%

100%

125%

150%

3/9/yyyy 6/19/yyyy

S&P China BMI

FTSE China 25

AlphaShares China Allcap


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Understanding China Sectors

-100

-80

-60

-40

-20

020

40

60

80Underlying Index Total Returns

AlphaShares Tech

AlphaShares Real Estate

Solactive Tech

Solactive EnergySolactive Industrials

Solactive Materials

Solactive Consumer

Solactive Financials

IndXX Infrastructure


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Understanding China Small Caps

-20%

-10%

0%

10%

12/31/yyyy 6/22/yyyy

FXI HAO ECNS


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Playing the Renminbi

000%

003%

005%

008%

6/16/yyyy 6/19/yyyy

Renminbi Spot CNY CYB


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Trading China:The Irrelevance of iNav


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Q & A

Burton Malkiel

Professor of Economics

Princeton University

Chief Investment Officer

AlphaShares

Dave Nadig

Director of Research

IndexUniverse

Sponsored by:


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