|AlphaShares Indexes||July 2012||2012||1 Year||3 Year|
|AlphaShares China All-Cap Index (NYSE: YAO)||0.48%||3.58%||-17.11%||-0.53%|
|AlphaShares China Small-Cap Index (NYSE HAO)||-3.02%||-1.05%||-26.81%||-5.25%|
|AlphaShares China Real Estate Index (NYSE: TAO)||3.62%||26.34%||-3.83%||1.95%|
|AlphaShares China Technology Index (NYSE: TAO)||-8.66%||-5.38%||-29.28%||-0.77%|
|AlphaShares Yuan Bond Index (NYSE: TAO)||-0.06%||0.81%||NA%||NA%|
|FTSE/Xinhua China 25 Index||3.67%||1.95%||-15.21%||-3.98%|
|CSI 300 (A-Shares)||-4.91%||0.27%||-19.06%||-11.99%|
China's economy cooled to its weakest rate of growth in more than three years, expanding 7.6% in the second quarter from a year earlier after growing 8.1% in the first quarter of 2012. In June, the Peoples' Bank of China (BPoC) responded to economic concerns by cutting interest rates for the first time since 2008. On July 5th, the PBoC cut rates for a second time in less than a month, showing that officials remain committed to their minimum growth target of 7.5% for the year. The one-year lending rate was lowered 0.31% to 6% on the same day the European Central Bank cut its key rate and the Bank of England announced it was stepping up its economic stimulus program. The moves encouraged talk in the trading community of a coordinated response to the slowdown in the global economy in the wake of continued worries about the European debt crisis.
Whereas economic growth may be slowing, M&A activity is heating up in the North Sea, as China makes its first significant investment in its oilfields through two major deals. State-controlled energy giant CNOOC (883 HK) unveiled China's richest foreign takeover bid yet on July 23rd by agreeing to buy Canadian oil producer Nexen Inc for $15.1 billion. That same day, Chinese refiner Sinopec (338 HK) said it would pay $1.5 billion for a 49% state in the UK unit of Canada's Tailsman Energy. The deals have to be approved by the Canadian and British governments respectively. On the month, CNOOC gained 2.13%, while Sinopec shares fell -7.92% in July. On the larger picture, history has seen China chase big resources in tangible assets that act as a diversifier to their US Treasury holdings, as well as securing strategic commodities that it needs to fuel its economic growth - while slowing, the 7.5% floor to its growth rate is well above most global economies.
The Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), closed July at 22.41, or up 2.99% from last month. In the US, CBOE S&P 500 Volatility Index (VIX), gained 10.66% on the month to finish at 17.57. A year ago, the CHIX closed July 2011 at 22.04, while the VIX closed at 25.25 a year ago. Shortly after, implied volatilities in the global options markets got spooked following a violent sell-off in equities after the announcement that Standard & Poor's was lowering its US credit rating from AAA to AA+, marking the first time in 70 years that US treasury debt had not received the highest rating from S&P. However, after the notable increase in perceived risk in the US debt markets, the "fear gauge" of the US equity market is now -25.25% lower from where it was before the downgrade. Yet China, who likely has the most favorable government balance sheet in the world with $3.2 trillion in currency reserves, has seen the perceived risk of its equity market actually uptick since the US downgrade.
The AlphaShares China All Cap Index (Bloomberg: ACNACTR) gained 0.48% in July to bring YTD returns to 3.58%. However, China equities are off -17.12% year-over-year while going through a steep correction last fall, while the S&P 500 has gained 6.74% over the last 12 months since its downgrade. So nearly a year after the S&P rating agency shook the global markets with its first downgrade of US debt, equities in the world's largest 'developed market' have performed even stronger with lower perceived risk. Yet in the world's largest 'emerging market', Chinese equities have experienced a correction and fear is even higher than at the end of last July. The one relationship that continues to hold up even in this counterintuitive environment is that equity market performance and changes in implied volatilities continue to be negatively correlated.
Telecom stocks in China proved to be the best-performing sector this month, gaining 9.96% in July. For the month of June, Chinese telecoms added an impressive 11.82 million new subscribers, putting the total number of Chinese mobile phone users at 1.05 billion. More importantly, there has been a dramatic increase in Chinese 3G subscriptions, with 176 million added in June (a 118% year-over-year increase). The 3G market is an important indicator of profitability of the three major Chinese telecom outfits of China Mobile, China Telecom, and China Unicom. The three stocks posted gains of 7.37% (941 HK), 19.94% (728 HK), and 17.27% (762 HK) respectively. China Mobile (941 US) was the largest positive contributor to overall index returns this month, given it is the largest weight of the three index constituents. The stock makes up 5.68% of the AlphaShares China Index, and is regularly recapped at the 5% max weight at its semiannual rebalance.
On the other end of the return spectrum, New Oriental Education (EDU UN), was the largest negative contributor to index returns in July. The company is China's largest provider of educational services and has only a 26 bps weight in the index after falling -52.44% this month. On July 17th, the US Securities and Exchange Commission announced it is investigating the firm. Muddy Waters, a famed short-selling firm, followed with a report containing allegations of fraud. In China, most parents dig deep to give their child (usually only one) the best chance at success, which is why education ranks second only to property in discretionary spending in China ($140 billion in 2011).
For July, larger cap names fared better than their small cap peers, as the former (represented by the FTSE China 25 Index) gained 1.95% and the latter (represented by the AlphaShares Small-Cap index: ACNSCTR) fell -1.58%. - bringing YTD returns to -1.66% and 2.03% respectively so far in 2012. The AlphaShares China Real Estate Index (ACNRET) continues its impressive 2012 campaign, gaining 3.62% to bring YTD returns to 26.34%.
|Jonathan J. Masse, CFA||Dr. Burton G. Malkiel|
|Senior Portfolio Manager||Chief Investment Officer|