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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870
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960
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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
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The Chinese economic revolution capitalism
is reintroduced to China
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Purchasing-Power-Parity Valuation in Current US Dollars; Source: IMF
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500,0
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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.
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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
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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)
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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%
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40%
30%
20%
10%
0%
1980 1984 1988 1992 1996 2000 2004 2008 2010
Investment/GDP
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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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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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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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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
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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%
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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%
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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%
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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%
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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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