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AlphaShares Monthly Letter: October 2010

AlphaShares Indexes October 2010 2010 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) 4.68% 12.35% 13.10% -8.35%
AlphaShares China Small-Cap Index (NYSE HAO) 3.98% 18.30% 21.37% -2.34%
AlphaShares China Real Estate Index (NYSE: TAO) 2.55% 10.09% 11.95% -6.89%
FTSE/Xinhua China 25 Index 4.66% 5.26% 4.08% -12.12%
CSI 300 (A-Shares) 15.43% -2.71% -0.94% -12.56%

China News:

The Peoples Bank of China (PBOC) caught the market by surprise when it raised its benchmark deposit and lending rates 25 basis points—its first increase since December 2007—with the intent of heading off potential asset bubbles. China”s GDP grew at 9.6% in the third quarter, slowing from 11.9% and 10.3% in the first and second quarters respectively. In September, China”s Consumer Price Index (CPI) rose to a 23-month high of 3.6% year-over-year.

While the interest rate hike itself was not large, it signals that the foundation for Chinese growth is firm and that the policy focus has shifted from concerns over an economic slump to worries about economic overheating. Chinese policymakers are becoming more confident in the economy—especially regarding the strengthening momentum for domestic demand. Retail sales rose 18.8% over a year ago, and a 1.5% gain from the month prior.

Moody’s Investors Service announced that it is reviewing China’s government bond rating for a possible upgrade. In a statement, the credit rating agency cited, “the resilient performance of the Chinese economy following the onset of the global financial crisis, and expectations of continued strong growth over the medium term.” Chinese bonds currently have an A1 rating.

China Equity Markets:

The AlphaShares China All-Cap Index (Bloomberg: ACNACTR) hit a 34-month high on October 25th and finished the month up 4.68%. The AlphaShares Small-Cap index (Bloomberg: ACNSC) underperformed the larger-capitalized the FTSE/Xinhua Index 3.98% to 4.66% in October, but has posted superior YTD returns (18.30% compared to 5.26%). Global equity markets have been in rally mode since August in part due to expectations that the US Fed would initiate another round of quantitative easing. However, the pickup in volatility alongside the market upswing indicates that options traders remain cautious. The FTSE/ Xinhua options contracts traded over 1.4 million contracts in October, up over 22% from September as investors look for ways to hedge against rumors of protectionist backlash against what is widely considered an undervalued Chinese yuan.

Last month, Brazil’s finance minister Guido Mantega cautioned of potential collateral damage under the immediate threat of a “currency war” brewing between the US and China. These concerns were echoed by world leaders throughout the month. The European Financial Services Commissioner Michel Barnier commented that China has “a responsibility that they must answer to” in regards to Chinese policy makers” commitment to help rebalance the global economy—particularly in the context of its currency. Mexican Billionaire Carlos Slim said that competitive devaluations “won’t succeed” and believes that Chinese domestic demand may be spurred by a higher valued currency that could help other countries in the world economy.

Chinese financials posted the best sector returns this month, gaining 8.16%. The Bank of China (3988 HK) and China Construction Bank Corp (939 HK) won financial regulatory approval for their plans to raise as much as a combined $20.3 billion to replenish capital. Both stocks reported better-than-expected third quarter earnings, and gained 14.13% and 8.80% respectively throughout the month and were the largest contributors in index returns this month.

After posting posting September’s second-best return (+39.45%), BYD Company Limited (1211 HK) was the worst performer in October (ᆬ.11%). Last month, Warren Buffet toured the company’s operations and told China Central Television, “If we’re buying shares, we won’t announce it… I can absolutely promise you we’re not selling.” Other market participants, who don’t have as long of a holding-period as the “Oracle from Omaha”, sold off shares after the company released earnings that were down sharply as sales for its gasoline-fueled cars took a nosedive. In addition, the company delayed its much-hyped launch in California of one of its all-electric battery cars.

Baidu (BIDU UN) continued its impressive run in 2010, gaining 7.20% in October—adding to its already-best YTD performance, up 167.51% so far this year. It hit an all-time high of $112.87 on October 27th. Shares traded lower after rival Alibaba (1688 HK; China”s largest online commerce company) set up a website for its two-year-old TaoBao Mall as it aims to fend off rising competition from Baidu, operator of China”s largest website.

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.