The China Opportunity
CHINA
Most great investments begin in discomfort.– “The things most people feel good about – investments where the
underlying premise is widely accepted, the recent performance has been positive and the outlook is rosy – are unlikely to be available at bargain prices.
Rather, bargains are usually found among things that are controversial,
that people are pessimistic about, and that have been performing badly
of late.”
CHINA MARKET UPDATE
Wind Bloomberg
2005200520062006200620062007200720072008200820082009200920092010201020102011201120112012201220122013201320132014700
1700
2700
3700
4700
5700
6700
Scary Bubble
Where we are now
CHINA MARKET UPDATE
4/1/
2005
9/1/
2005
2/1/
2006
7/1/
2006
12/1
/200
6
5/1/
2007
10/1
/200
7
3/1/
2008
8/1/
2008
1/1/
2009
6/1/
2009
11/1
/200
9
4/1/
2010
9/1/
2010
2/1/
2011
7/1/
2011
12/1
/201
1
5/1/
2012
10/1
/201
2
3/1/
2013
8/1/
2013
1/1/
2014
6/1/
2014
11/1
/201
4
4/1/
2015
9/1/
2015
2/1/
2016
0
50
100
150
200
250
300
350
400
0
1000
2000
3000
4000
5000
6000
7000
Earnings
Est Earning
Est Max
Est Min
CSI300 Index
CHINA MARKET UPDATE
Wind Bloomberg
2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
1
2
3
4
5
6
7
8
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
China USA
Great Recession
Fear?Risk Premium?
CHINA MARKET UPDATE
Bloomberg Estimates End if Mayt
2007 October Today0
5
10
15
20
25
30
35
40
45
Top40 index
DAX index
MSCI World
S&P 500
FTSE 100
CSI 300 (China)
CHINA SECTOR UPDATE
Inet, Wind
Financ
ials
Indu
stria
ls
Mat
erial
s
Consu
mer
Disc
retio
nary
Info
rmat
ion T
echn
ology
Utilitie
s
Energ
y
Consu
mer
Sta
ples
Health
Car
e
Teleco
mm
unica
tion
Servic
es0
5
10
15
20
25
30
35
China South Africa
1960 AND MODERN CHINA
Born in 1960 Born in 2009
Life Expectancy 47 73
Per Capita consumption at birth $102 $1429
Per Capita consumption at Death $1129 $21400
Lifetime Consumption $16443 $632024 (38x)
CHINESE AND INDIAN CONSUMERS IN THE NEXT DECADE
2010 Income Distribution 2020 income distribution
Number of Households (Millions)
Share of households (%)Number of Households
(Millions)Share of households (%)
ChinaUpper 24 6 91 21Middle 109 28 202 47Lower 260 66 138 32
IndiaUpper 9 4 32 12Middle 63 28 117 45Lower 152 68 110 43
Billionaire’s 1 in 2004, 115 today
Movies total spend 17.6Billion RMB, up 40% a year compounded since 2006, 7x the market size, 2013 3Q growth up another 36%
Holiday makers, 20 Million in 2004, today 90 Million!
Chinese entrepreneurs believe in a 10 x 10 strategy, 10x the size in 10 years
COMPANY SPOTLIGHTS
Wind
Haier
2007 Now -
10
20
30
40
50
60
PE Ratio
Earnings Growth Revenue Growth0%2%4%6%8%
10%12%14%16%18%20%
Growth
2,007 2,008 2,009 2,010 2,011 2,012 2,013 2,014 -
5
10
15
20
25
30
35
40 ROENet Profit Margin
COMPANY SPOTLIGHTS
Wind
Huayu
2007 Now - 5
10 15 20 25 30 35 40 45 50
PE Ratio
Earnings Growth Revenue Growth0%
5%
10%
15%
20%
25%
30%
35%
40%
Growth
2,007 2,008 2,009 2,010 2,011 2,012 2,013 2,014 (5.00)
-
5.00
10.00
15.00
20.00
25.00 ROE
Net Margin
COMPANY SPOTLIGHTSMaoTai
2007 Now -
20
40
60
80
100
120
PE Ratio
Earnings Growth Revenue Growth0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Growth
2,007 2,008 2,009 2,010 2,011 2,012 2,013 2,014 -
10
20
30
40
50
60
ROE
Net Margin
COMPANY SPOTLIGHTSPingan
2007 Now -
10
20
30
40
50
60
PE Ratio
Earnings Growth Revenue Growth0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Growth
2,007 2,008 2,009 2,010 2,011 2,012 2,013 2,014 -
5.00
10.00
15.00
20.00
25.00
ROE
Net Profit Margin
CHINA RISK MAP
Government Directed Lending
Commercial Banks
Low Deposit Rates
Private Households
Shadow Banking
Unlisted SOEs / Policy
Banks
Private SMMEs
Government
Tight Lending Standards
GOVERNMENT
Huge Reserves Low debt to GDP Good government balance sheets with very small deficits Avenue to further develop taxation in China
– Capital Gains– Dividends– Benefit restructuring
Exports continue to be strong, although imports catching up
PRIVATE HOUSEHOLDS
Housing is a store of wealth Huge deposits for housing EXTREMELY low debt levels
– Still not used to debt – Consumption very low
20% of residential housing un-occupied– A 30% drop in prices will result in around 11% of these houses to be
underwater– A 30% drop in prices in occupied housing will only result in 2% of these
homes to be underwater– High level of deposit
Rules and regulation against speculation
HOUSE PRICE GROWTHY-o-Y change
-5%
0%
5%
10%
15%
20%
25%
01/0
7/20
05
01/1
0/20
05
01/0
1/20
06
01/0
4/20
06
01/0
7/20
06
01/1
0/20
06
01/0
1/20
07
01/0
4/20
07
01/0
7/20
07
01/1
0/20
07
01/0
1/20
08
01/0
4/20
08
01/0
7/20
08
01/1
0/20
08
01/0
1/20
09
01/0
4/20
09
01/0
7/20
09
01/1
0/20
09
01/0
1/20
10
01/0
4/20
10
01/0
7/20
10
01/1
0/20
10
01/0
1/20
11
01/0
4/20
11
01/0
7/20
11
01/1
0/20
11
01/0
1/20
12
01/0
4/20
12
01/0
7/20
12
01/1
0/20
12
01/0
1/20
13
01/0
4/20
13
01/0
7/20
13
01/1
0/20
13
01/0
1/20
14
01/0
4/20
14
Tier1 Cities (CNSB) 70 Cities (CNSB)
SMMES
Very difficult to get access to credit– Get expensive credit through shadow banking signal
Shadow banking actually works like a real bank / corporate bond market– Depositors get higher yield with higher risk– SMMEs get access to credit although expensive credit
Trusts make up only 7-10% of GDP HSBC research that 90% of products issued by trusts are issued by
companies with huge financial backing and profitability, will have no problems in making investors whole
In general trust credit spreads are around 5%, which implies a default rate of around 33% over 5 years for investors to still be better off invested in them, current default rates are tiny around 1%
UNLISTED SOES
Listed SOEs have some of the lowest debt levels across all companies– Makes sense as the privatisation / listing process started with the ones
that was best managed Unlisted SOE
– GOD HELP THEM…– Restructuring– Government bail out– Local access
Government reform plans shows that those with polluting, excess capacity and low productivity will be allowed to default and close– Myth that Government do not fire people– Civil service reforms in early 1990s resulted in around 50 million people
losing jobs before rehired in more efficient industry
FINANCIAL STABILITY REPORT2014
The Chinese Central Bank ran a stress test on the banks using the following scenario:– 4% GDP growth– Top 3 clients of each bank renege on their contracts– 30% default in developers– 15% default in private residential– Interest rate spread lowers by 100bps – Bad loans rises to 15%
CONCLUSION
Very Cheap Risky, growth slows down, new consumption model, reforms
– In the price already? Good Diversification Long term picture more stable
Equity Process [Client Logo]
CHINA BALANCED FUNDEquity Factor Allocation
Arbitrage; 6%Behavioural,
19%
Quality; 19%Historical Earn-
ings; 28%
Forecasted Earnings; 28%
Factor Allocation
FACTOR PERFORMANCE
Month Since Inception Value Behavioural Quality Value Behavioural Quality2013-04-23 -0.08% 1.52% 1.97% -0.08% 1.52% 1.97%2013-05-27 -3.22% 0.65% 1.69% -3.30% 2.19% 3.70%2013-06-26 0.65% -1.64% 2.79% -2.67% 0.51% 6.59%2013-07-25 -0.56% -1.92% -0.14% -3.21% -1.41% 6.44%2013-08-23 1.30% 2.58% -1.50% -1.96% 1.13% 4.85%2013-09-18 0.53% 2.05% -4.50% -1.43% 3.20% 0.13%2013-10-29 0.63% 1.09% -1.87% -0.81% 4.32% -1.74%2013-11-27 0.73% 1.26% -2.14% -0.09% 5.64% -3.84%2013-12-27 0.39% 1.96% 2.36% 0.30% 7.71% -1.58%2014-01-28 -0.02% 0.15% 0.11% 0.28% 7.87% -1.47%2014-02-26 0.38% 5.62% -1.04% 0.66% 13.94% -2.49%2014-03-26 1.70% 4.02% 0.91% 2.37% 18.52% -1.61%2014-04-24 0.20% -3.21% -0.60% 2.57% 14.71% -2.19%2014-05-27 0.45% -0.38% -0.34% 3.04% 14.28% -2.53%
ALPHA DISTRIBUTION
~-0.3
%
-0.3
%~-0
.25%
-0.2
5%~-0
.2%
-0.2
%~-0
.15%
-0.1
5%~-0
.1%
-0.1
%~-0
.05%
-0.0
5%~0%
0%~0.
05%
0.05
%~0.
1%
0.1%
~0.15
%
0.15
%~0.
2%
0.2%
~0.25
%
0.25
%~0.
3~
0.3%
~
0
100
200
300
400
500
600
700
800
900
Alpha Distribution
EQUITY CARVE-OUT ALPHA
2013
-03-
26
2013
-04-
09
2013
-04-
19
2013
-05-
06
2013
-05-
16
2013
-05-
28
2013
-06-
07
2013
-06-
24
2013
-07-
04
2013
-07-
16
2013
-07-
26
2013
-08-
07
2013
-08-
19
2013
-08-
29
2013
-09-
10
2013
-09-
24
2013
-10-
11
2013
-10-
23
2013
-11-
04
2013
-11-
14
2013
-11-
26
2013
-12-
06
2013
-12-
18
2013
-12-
30
2014
-01-
10
2014
-01-
22
2014
-02-
10
2014
-02-
20
2014
/03/
04
2014
/03/
14
2014
-03-
26
2014
-04-
07
2014
-04-
17
2014
-04-
29
2014
-05-
09
2014
-05-
21-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
Cumulative Alpha
MAY PORTFOLIO
Fin; 35%
Mat; 7%Ind; 13%
Util; 4%Tel; 0%
IT; 5%Eng; 5%
Con Dis; 11%
Con Stap; 7%
HC; 8%
Sectors
Fin Mat Ind Util Tel IT Eng Con Dis
Con Stap
HC-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
-4.09%
-0.86%-1.41%
0.86%
-0.45%
0.71%
-0.12%
-1.05%-0.29%
1.62%
Sector Under/Overweight
Great Wall Motor Co LtdHuadian Power International Corp Ltd
Hong Yuan Securities Co LtdQingdao Haier Co Ltd
Bank of Beijing Co LtdDashang Group Co Ltd
Anhui Gujing Distillery Co LtdAvic Capital Co LtdXiamen C & D Inc
Changjiang Securities Co LtdHuaxia Bank Co Ltd
0.0% 1.0% 2.0% 3.0% 4.0% 5.0%
Top 10 Over Weight
Industrial Bank Co Ltd
China Merchants Bank Co Ltd
Ping An Insurance Group Co of China Ltd
Gree Electric Appliances Inc
Haitong Securities Co Ltd
CITIC Securities Co Ltd
China Everbright Bank Co Ltd
China Pacific Insurance Group Co Ltd
Anhui Conch Cement Co Ltd
Kweichow Moutai Co Ltd
-3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0%
Top 10 Under Weight
FUND TILL END OF MAY
Prescient
2014 YTD Since Inception
Fund Gross of Fees in USD -7.38% -10.76%
CSI300 Total Return in USD -9.97% -14.32%
China CPI+3 in USD -0.71% 5.47%
-17.50%
-12.50%
-7.50%
-2.50%
2.50%
7.50%
-7.38%
-10.76%-9.97%
-14.32%
-0.71%
5.47%
Fund Performance
Fund Gross of Fees in USD CSI300 Total Return in USD China CPI+3 in USD
FUND AVAILABILITY
UCITS regulated fund in Ireland
Feeder fund structure in South Africa
China Debt Fund Opportunity
[Client Logo]
CHINA CONSERVATIVE FUND
As of Wednesday the 17th June – CNYZAR exchange rate is 1.62 ZAR per CNY– CNYZAR 1 year forward rate is 1.73 ZAR per CNY– Start with 100 rands buy CNY at 1.62 at the same time sell CNY forward
at 1.73 for 1 year ahead– 100 / 1.62 = 61.66 CNY– We earn 4.3% in CNY = 64.31 CNY– We sell CNY back to ZAR at 1.73– 111.07 ZAR– We make 11.07% in 1 year
This has no currency risk, assets invested in money market instruments in China– No duration risk
Arbitrage
CHINA CONSERVATIVE FUND
The biggest opportunity in China ATM comes from the mispricing of the forwards
Arbitrage
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
23-A
ug-0
9
23-O
ct-0
9
23-D
ec-0
9
23-F
eb-1
0
23-A
pr-1
0
23-J
un-1
0
23-A
ug-1
0
23-O
ct-1
0
23-D
ec-1
0
23-F
eb-1
1
23-A
pr-1
1
23-J
un-1
1
23-A
ug-1
1
23-O
ct-1
1
23-D
ec-1
1
23-F
eb-1
2
23-A
pr-1
2
23-J
un-1
2
23-A
ug-1
2
23-O
ct-1
2
23-D
ec-1
2
23-F
eb-1
3
23-A
pr-1
3
23-J
un-1
3
23-A
ug-1
3
23-O
ct-1
3
23-D
ec-1
3
23-F
eb-1
4
23-A
pr-1
4
EUR assets CNY assets
CHINA CONSERVATIVE FUNDPotential Fund Asset Allocation
CSI Short Term Bond Index (1 year) Portfolio
Weighting Return Weighting Return
0 - 3 months 21% 4.2% 25% 4.7%
3 - 6 months 30% 4.3% 25% 4.3%
6 - 12 months 49% 4.6% 50% 5.2%
Weighted Return 4.4% 4.7%
CHINA CONSERVATIVE FUNDArbitrage
CHINA CONSERVATIVE FUNDArbitrage
CHINA CONSERVATIVE FUND
Fixed income fund with less than 2 year maturity– Average 1 year– Maximise yield– Avoid defaults– Building block
3 classes– CNY– USD– ZAR– Segregated
Official benchmark – Chinese CPI – Chosen also because China lacks a proper short term fixed income
benchmark
Thank you
Regulatory InformationThis presentation has been compiled to provide factual information on the product offered and does not constitute advice. A copy of this presentation is available from Prescient upon request.
Prescient Investment Management is a Financial Services Provider authorised under the Financial Advisory and Intermediary Services Act of 2002 (FSP 612).
Business address:
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Westlake, Cape Town, 7945
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