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AlphaShares Monthly Letter: February 2010

AlphaShares Indexes February 2010 2010 1 Year 3 Year
AlphaShares China All-Cap Index 3.41% -5.94% 81.46% 11.73%
AlphaShares China Small-Cap Index 3.81% -2.97% 121.60% 4.50%
AlphaShares China Real Estate Index 6.46% -6.98% 91.66% 3.18%
FTSE/Xinhua China 25 Index 1.78% -7.77% 62.70% 7.45%
CSI 300 (A-Shares) 2.43% -8.21% 53.61% 13.51%

China News/Highlights:

The AlphaShares China All-Cap gained 3.41% in February, as the large-cap FTSE/Xinhua and local A All-Shares CSI 300 increased 1.78% and 2.43% respectively in a very volatile month. The Year-to-date return numbers got as low as -11.65%, -12.04%, and -12.01% respectively as global markets sold off as fears peaked over the troublesome debt levels in Greece, Portugal, and Spain. The Hang Seng dropped below 20,000 for the first time since September 2009. Anxiety eased later in the month, as there was a pickup in global M&A activity, and the European Union pledged aid to Greece and to maintain financial stability of the region. As the global markets gained comfort, the three China indexes finished February with 2010 YTD returns of -5.94%, -7.77% and -8.21% respectively.

The growing comfort in the equity markets also helped ease the major volatility indexes, as the CHIX (the AlphaShares China implied Volatility Index) and VIX (the CBOE S&P 500 Volatility Index) were off -8.68% (26.85) and -20.80% (19.27) from where it started the month – after both spiked as high as 32.50 and 26.08 earlier in the month respectively. The CHIX remained more firm than the VIX, as local concerns over inflationary concerns and speculation about a potential appreciation of the Chinese renminbi continued to cloud the local market.

In addition, the People’s Bank of China (PBoC) added its second hike in 2010 to its required reserve ratio (RRR) — which added to the speculation that the government may allow its currency to appreciate beyond 6.83 per dollar where it has been since July 2008, protecting Chinese exporters from weakness in global demand. However, the central bank also gave its clearest sign yet of the context surrounding its stimulus pullback, noting it will “reasonably guide monetary conditions to gradually move toward a normal situation from an anti-crisis situation” and that it will “strengthen liquidity management, keeping reasonable and appropriate banking-system liquidity and fostering reasonable growth of money supply and credit.” It is important to note that this credit tightening is aimed at slowing, but not stopping Chinese GDP growth.

China Equity Markets:

Even as the central bank emphasizes the gradual normalization of monetary conditions by adopting a prudent liquidity policy, interest rate concerns weighed on the local financials, whose 1.19% return was the worst Chinese sector of the month. Industrial and Commercial Bank of China, ICBC (1398 HK), the world’s largest bank by market capitalization declined -3.65%. China Construction Bank (939 HK), the country’s 2nd-biggest lender fell -1.81%. The two stocks were the largest detractors to index performance this month, and both have weights in the AlphaShares All Cap index over 4.60%.

On the positive side, Technology and Consumer Discretionary led sector returns in China equities this month gaining 9.42% and 8.00% respectively. Baidu (BIDU), China’s largest search engine, was also its largest positive contributor to index returns, gaining 25.98% in February. The company topped Wall Street expectations with a profit increase of 50%, as revenues climbed 41% in Q4. Its balance sheet holds $671 million in cash with no debt or interest expenses. Shares closed the month at an all-time high of $518.68.

China-based travel service provider Ctrip.com (CTRP) was the best performer in the Consumer sector, gaining 21.18% this month. It reported a 57% surge in profits in Q4 from last year, buoyed by a 42% increase in revenues. The company said in a statement that expects its net revenue will continue to grow at a year-on-year rate of around 30% in 2010.

The AlphaShares China All-Cap Index outpaced the traditional large cap benchmarks this month by being overweight in small cap names (AlphaShares China Small cap gained 3.81%), and by having a more diverse exposure to the sectors that outperformed this month: 11.77% weight in Techonology and 11.26% weight in Consumer sectors (Discretionary and Staples). The FTSE/Xinhua holds no consumer stocks, and only holds one technology name (BYD Company at a 3.13% weight) among the 25 stocks in the index.

Last, a number of prominent commentators, from hedge fund manager James Chanos to investor blogger Vitaliy Katsenelson, have contributed to the overriding fear about credit excess and an overinvestment bubble - especially among in some property markets - that may bring economic turmoil. While there have always been cynics regarding China’s growth, the International Monetary Fund (IMF) forecasts China’s government debt-to-GDP ratio to reach 22% in 2010, while the US and Japan are on pace to reach 94% and 227% respectively. In addition, the IMF forecasts China’s growth this year at 10% and noted “key economies in Asia are leading the global recovery.”

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.