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AlphaShares Monthly Letter: December 2011

AlphaShares Indexes December 2011 2011 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) 1.26% -17.96% -17.96% 15.24%
AlphaShares China Small-Cap Index (NYSE HAO) -1.84% -32.82% -32.82% 17.03%
AlphaShares China Real Estate Index (NYSE: TAO) 3.13% -24.75% -24.75% 14.96%
AlphaShares China Technology Index (NYSE: TAO) -2.99% -23.22% -23.22% 26.61%
AlphaShares Yuan Bond Index (NYSE: TAO) -0.69% NA% NA% NA%
FTSE/Xinhua China 25 Index 2.82% -16.98% -16.98% 9.30%
CSI 300 (A-Shares) -5.79% -20.49% -20.49% 11.74%

China News:

China's annual economic conference was held during the month, December 12-14th. The statement issued after the conference highlighted that authorities will focus on maintaining stable economic growth as the key policy priority for 2012, with economic restructuring and managing inflation expectations being the other key policy targets. On the macro policy front, the key theme remains "pro-active fiscal policy" and "prudent monetary policy" in order to support steady and healthy economic growth.

With the US in an election year in 2012, it is sure that political hopefuls will continue their criticism that the Chinese government manipulates its currency, keeping it artificially low, giving Chinese exporters an unfair advantage over their American counterparts by making Chinese goods cheaper overseas. It is expected that Washington will continue to push for a revaluation. However, the yuan appreciated 4.96% against the dollar in 2011, and is up 8.47% since June 2010 when China began to let its currency gradually float up in the face of increased inflation. The currency rate reached 6.3 yuan/dollar for the first time in 18 years.

On December 26th, China (the 2nd largest economy) and Japan (the 3rd largest economy) agreed to start the direct trading of their currencies without having to transact using US dollars. They together hold the world's largest foreign-currency reserves, with China holding $3.2 trillion, and Japan holding $1.3 trillion. The currency agreement is part of a move away from using the US dollar, Chinese officials have made it clear they believe the international economy is too heavily denominated by the dollar. Japan will also apply to buy Chinese bonds next year, allowing it to accumulate more renminbi in its foreign-exchange reserves, the two countries are projected to be each other's biggest trading partners over the next century.

China Equity Markets:

The AlphaShares China All Cap Index (Bloomberg: ACNACTR) gained 1.26% in the final month of the year to give it an annual return of -17.96%. Small cap stocks (represented by the AlphaShares Small-Cap index: ACNSCTR) fared worse than their large cap counterparts (represented by the FTSE China 25 Index) during the month (falling -1.84% versus the 2.82% gain) and for the year (-32.82% versus -16.98%).

The AlphaShares Chinese Volatility Index (ASCNCHIX or "CHIX") closed 2011 at 26.38, down -17.10% in December but still up 33.98% since the start of the calendar year. During 2011, the CHIX traded as low as 17.24 and as high as 53.35. The CHIX/VIX premium started the year at 10.9%, and finished at 12.54%.

Looking only at the end-of-year volatility numbers does not do justice to what was a year full of horrific swings in fear in global equities. Market fears screamed in March, following the Tohoku earthquake and subsequent nuclear disaster in Japan. With the Nikkei VIX, the VNKY, trading as high as 69.88 for Japanese equity markets, volatility in the US and China spiked to 29.40 and 27.21 that month. Soon thereafter, both the VIX and CHIX traded in the teens as fears seemed to hibernate later that spring.

However, the late summer/early fall saw angst in global option volatility indexes peak around 50 as markets panicked on whispers of a US double-dip recession, and a hard-landing in China. It took a coordinated effort of six central banks to lower borrowing costs at the end of November in order to settle global markets in December. Separately, China cut its reserve requirement ratio (RRR) for the first time in nearly three years, and its soothing effects on local equity markets took hold to close out the year.

Also helping relieve investor fears at year end was the Shanghai Securities News report from December 20th that cited that China's national pension fund injected 10 billion CNY (~$1.6 billion) into the domestic stock market. Market watchers are hoping this may be a sign from the National Council for Social Security that local stocks may be close to bottoming out, citing signs of long-term value in the recent pricing of equities. Many observers feel that the pension fund is responding to the call of the government to help stabilize the stock market.

The move reminded many traders of when China's sovereign wealth fund (SWF) boosted its holdings in the "Big Four" lenders soon after the Chinese equity markets cratered to their lowest points in early October. Central Huijin Investment, a unit of the $400 billion China Investment Corp (CIC), said the thenpurchases were aimed at supporting the state lenders, whose share prices have tumbled over the year due to increased lending restrictions and capital requirements. Much like the CIC's intervention that had a positive effect on the financial sector over the month of October, this move by the pension fund helped financial stocks to again be the best performing sector this month, as the group gained 6.43% in December. Two of the big four China banks were the largest positive contributors to equity returns this month as the Bank of China (3988 HK) and ICBC (1398 HK) gained 18.81% and 7.08% in December.

Meanwhile, Consumer Staple stocks were the worst performing sector in December (-5.05%) after being the second best performing sector in November (+0.56%). Tingyi (322 HK) and Want Want China (151 HK) had the second and third largest positive contributors to index returns last month after it was announced on November 11th that both stocks would be added to the widely followed Hang Seng Index. The index change went effective December 5th, however, both stocks dramatically underperformed their peers in the month of the index addition as they declined -3.04% and -1.61% respectively in December - once again showing the detrimental "index effect" of largely followed indexes.

Sincerely,

Jonathan J. Masse, CFA Dr. Burton G. Malkiel
Senior Portfolio Manager Chief Investment Officer

Disclaimer text

Past performance is no guarantee of future results. The information presented in this letter is for background purposes only and is subject to updating, revision and amendment, and no representation or warranty, expressed or implied, is made, and no liability is accepted by AlphaShares, LLC in relation thereto. This letter is neither an offer to sell nor a solicitation of any offer to buy interests in the Fund. Any such offering is made only pursuant to the Fund’s Private Placement Memorandum and subscription agreement, which should be read in their entirety. No offer to purchase shares in the Fund will be accepted prior to receipt by the offeree of the aforementioned documents and completion of all appropriate documents. These materials have been sent to you in a confidential manner. The information contained herein may be proprietary. No part of these materials may be reproduced in any manner without the Investment Manager’s prior consent.