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AlphaShares Monthly Letter: March 2012

AlphaShares Indexes March 2012 2012 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) -6.53% 11.01% -12.89% 17.84%
AlphaShares China Small-Cap Index (NYSE HAO) -8.68% 11.40% -22.57% 19.29%
AlphaShares China Real Estate Index (NYSE: TAO) -9.10% 16.41% -10.87% 19.76%
AlphaShares China Technology Index (NYSE: TAO) -1.99% 17.95% -16.63% 28.69%
AlphaShares Yuan Bond Index (NYSE: TAO) -0.07% 1.50% NA% NA%
FTSE/Xinhua China 25 Index -9.09% 6.05% -14.98% 11.38%
CSI 300 (A-Shares) -6.85% 4.68% -19.74% 1.96%

China News:

China opened its annual parliamentary session and announced on March 5th that it would be cutting the country's projected economic growth rate to 7.5% while vowing to "make progress while maintaining stability" in 2012. It marked the first time China has reduced its annual economic growth target, after setting it at 8% in 2005 - indicating that leaders are determined to cut reliance on exports and capital spending in favor of consumption to better balance the economy going forward. Premier Wen Jiabao delivered the state-of-the-nation speech to the National People's Congress, citing the nation needs to shift to a more sustainable and efficient economic model and achieve "higher-quality development over a longer period of time." He also said the country is risking another Cultural Revolution unless it presses ahead with political change.

A week later, China shocked the world by announcing its largest trade deficit in more than two decades. The country has long been a net export powerhouse; however, the February numbers showed the world's second largest economy imported $31.5 billion more goods and services than it exported. The country announced that same weekend that inflation eased to the slowest pace in 20 months - Consumer prices gained 3.2% in February from a year earlier. The deceleration in net exports along with cooling inflation is boosting the case for stimulus to combat any further slowdown and ensure stable economic growth.

Despite the IMF (International Monetary Fund) calling for a soft-landing in China at a conference in Hong Kong on March 18th, recent data suggests the opposite, as car sales, cement production, steel production, and construction stocks were all down. While bears view the weak economic data as proof of a hardlanding, and call for China equities to be a consensus underweight, the broader long-term view is to acknowledge that the slowdown is the result of a drastic tightening by the central bank intended for the economy to move towards a more balanced growth and a steadier pace.

China Equity Markets:

Going into March, Chinese H-Share Indexes were among the best performing global markets, but reversed the early 2012 trend with sharp down moves this month. The broad-based AlphaShares China All-Cap Index (Bloomberg: ACNACTR Index) fell -6.53% this month, bringing its first-quarter return to 11.01% - China's best quarterly return in over a year.

The AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), fell -12.29% to finish March at 21.48. The CHIX is down -19.21% YTD after beginning 2012 at 24.49. The Chinese "fear gauge", as implied volatility indexes are commonly referred, traded as low as 20.67 on March 16th's "Triple Witching" Friday - the day of the month that stock options, index options and index futures expire.

In the US, CBOE S&P 500 Volatility Index, or VIX, fell -15.90% in March to close at 15.50 after starting the year at 23.40. It traded as low as 14.26 on March 25th - its lowest level since June 2007. The CHIX/VIX spread closed the month at a 38.58% premium, and traded as wide as 54.35% on March 26th - its widest level in 31 months. Historically, this "China vs US Fear" spread has traded near a 26% premium, and was even inverted as recently as last September. The renewed hard-landing fears for China are keeping implied volatilities at stubbornly high levels relative to the US.

For the month of March, both the Materials and Financial sectors weighed on overall index returns declining -13.56% and -11.77% respectively. The Industrial and Commercial Bank of China (1398 HK) was the largest negative contributor to index returns this month in both China and overall emerging markets indexes. The stock fell -12.04% after announcing a lock-up period barring the sale of its shares had ended, giving Goldman Sachs (GS US) the right to sell its stake. The South China Morning Post reported that the US bank approached several institutions about the possibility of selling a "big chunk" of its ICBC shares.

Meanwhile, Consumer Staples and Healthcare posted positive returns this month gaining 1.14% and 2.38% respectively. However, the two largest positive contributors to overall index returns came from the technology sector as the AlphaShares Technology Index (ACNIT Index) slip -1.99% this month. Baidu (BIDU US) gained 6.63% in March and hit an 8-month high during the month. Tencent (700 HK) gained 7.11% in March and was named Citi's top China Pick. While an overall slowdown (soft or hard) is being seen as a fact, internet portals are being viewed as a more unconventional defensive replacement position as they are expected to benefit from the government's efforts to boost consumption.

Premier Wen Jiabao said home prices are still far from reasonable levels in a March 14th speech, causing investors to be concerned that property curbs may be kept in place for longer than previously expected. The government's two-year effort to control the property market helped spur a 26% drop in home sales in the first two months of 2012. The AlphaShares China Real Estate Index (ACNRE) traded down -9.10% in March bringing YTD returns to 16.41%. Wen also noted that the yuan may be near equilibrium and that policy makers will allow greater movement in the exchange rate. After closing at an all-time monthly high in February at 6.2938 CNY/USD, the yuan paused in March, slipping -0.07%.

Sincerely,

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

Disclaimer text

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