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AlphaShares Monthly Letter: July 2011

AlphaShares Indexes July 2011 2011 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) -0.24% 2.52% 11.56% 6.43%
AlphaShares China Small-Cap Index (NYSE HAO) -3.20% -9.17% 5.13% 12.51%
AlphaShares China Real Estate Index (NYSE: TAO) 1.48% -1.14% 11.20% 7.34%
AlphaShares China Technology Index (NYSE: TAO) 0.86% 2.73% 11.99% 16.92%
FTSE/Xinhua China 25 Index -0.79% -0.16% 5.90% -0.29%
CSI 300 (A-Shares) -1.73% -1.49% 8.22% 3.90%

China News:

China's economy grew at a slower pace last quarter, which may ease 2nd-half 2011 inflation pressures in the world's second largest economy. Q2 Gross Domestic Product expanded 9.5% from a year earlier after expanding at a 9.7% clip in Q1. Monetary tightening has slowed the pace of the nation's expansion, and China's central bank increased interest rates for the third time this year, raising them 25 bps to 6.56% on July 6th. Premier Wen Jiabao reiterated in a July 11th speech that stabilizing prices remains a top priority. June inflation came in at 6.4% - its fastest pace since July 2008 and acceleration from May's 5.5% rate.

Still, the recent monetary contraction offsets the overhanging belief of a "Beijing put" - which refers to the assumption that, when faced with a dramatic slowdown, the Chinese government will step in immediately to stimulate growth - with their preferred method being the commodity-friendly expansion in fixed asset investment. Wen highlighted that the country's 2nd-half macro policy will (1) ensure "steady and relatively fast" growth, (2) faster economic restructuring, and (3) managing the inflation expectations.

China Equity Markets:

The AlphaShares China All Cap Index (Bloomberg: ACNACTR) slipped -0.24% in July, bringing its YTD return to 2.52% as the overall China stock market has remained relatively range bound this year. 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) this month, falling -3.20% and -0.79% respectively. They have returned -9.17% and -0.16% YTD.

Most major global volatility indexes spiked at the end of July, with the AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), closing July at its intra-month high of 22.04 - an increase of 17.11% from June. Going into the final days of July, the world's option traders watched anxiously as President Obama and the U.S. Congress tried to hammer out a last-minute agreement to raise the country's debt ceiling ahead of an August 2nd deadline. In the States, the CBOE S&P 500 Volatility Index, or VIX, spiked 54.96% in July, rising from 16.52 to 25.60. This additional political risk brought the US "Fear Index" to finish the month at a 12.71% discount to the CHIX, which traditionally trades higher than the VIX. The CHIX ended at a 13.92% premium to the VIX in June. The lines between the traditional classification of "risky" emerging markets and "established" developed markets are becoming increasingly blurred as countries' balance sheets are coming under the microscope of global rating agencies as they readjust their approach to gauging risk.

The AlphaShares China Technology Index (ACNITTR) gained 0.86% this month to bring its YTD return to 2.73%. Baidu (BIDU UN) was the largest positive contributor to China Index returns this month, gaining 12.09%. The company closed at a record $164.36 on July 26th, after many analysts raised their price targets for the company after its 2Q net income and Q3 revenue forecasts beat estimates. The company accounted for 75.9% of China's search-engine market by revenue in the second quarter, rising from 75.8% in the prior three months.

China Mobile (941 HK) was the second largest positive performer this month, as shares gained 7.53%. It is also the world's largest phone company by market value and by users. It added 5.6 million subscribers in June, bringing its total users to 616.8 million. Currently, China Unicom (762 HK) is the sole operator offering Apple's smart-phones, but many analysts speculate that it is only a matter of time before China Mobile, and the third largest, China Telecom (728 HK) begin offering Apple products.

As to how serious the country is about cleaning up corruption, China Mobile's former Vice Chairman and Executive Director, Mr. Zhang Chunjiang was sentenced to death (!) following a conviction for bribery. The sentence has been suspended for two years, and pending good behavior, it may then be changed to life in prison.

Rail-related stocks were hurt on news of a July 23rd collision of two high-speed trains that killed 40 people. China Railway Construction (1186 HK) and China Railway Group (390 HK) dropped -26.70 and -20.13% respectively in July. Meanwhile, airline stocks rose in a bit of a ghoul rally. Air China (753 HK) gained 2.06% on the month, while China Southern Airlines soared 20.13%.

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.