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AlphaShares Monthly Letter: October 2012

AlphaShares Indexes October 2012 2012 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) 5.26% 13.36% 4.98% 1.49%
AlphaShares China Small-Cap Index (NYSE HAO) 8.03% 11.41% 2.45% -1.48%
AlphaShares China Real Estate Index (NYSE: TAO) 1.94% 39.08% 28.00% 4.84%
AlphaShares China Technology Index (NYSE: TAO) -1.66% 4.26% -8.09% -2.07%
AlphaShares Yuan Bond Index (NYSE: TAO) 1.28% 3.42% 2.35% NA
FTSE/Xinhua China 25 Index 6.18% 9.80% 3.37% -2.35%
CSI 300 (A-Shares) -0.89% -0.83% -12.86% -8.46%

China News:

China surpassed the US for the first time since 2003 as the world’s largest recipient of global foreign direct investment in the first half of 2012, as global investors are still confident in the world’s second-largest economy despite its slowdown. While China’s third-quarter GDP numbers came in at its slowest pace in three years, it still came in at 7.4% growth. In addition, China manufacturing expanded for the first time in three months as output and new orders climbed, adding to signs indicating that growth in the world’s second largest economy is successfully rebounding after a seven quarter slowdown. The Purchasing Managers’ Index (PMI), the official gauge of local manufacturing, climbed to 50.2 in October from 49.8 in September, according to the National Bureau of Statistics and China Federation of Logistics and Purchasing.

While growth has been coming in slower than it has been in the past, it is certainly more reassuring to global options traders that China’s government is successfully navigating its ‘soft-landing’ as the AlphaShares Chinese Volatility Index, or “CHIX” (Bloomberg: ASCNCHIX), finished October at 18.61, after trading at its lowest level since May 2011 on October 19th’s expiration Friday when it closed at 17.45. In the US, the CBOE S&P 500 Volatility Index, or VIX finished the month at 18.60. The CHX/VIX spread, also referred to as the measure of relative fear in the China equity market over that of the US equity market, finished the month at a miniscule 5 basis points premium – marking the lowest the spread has traded at since August of 2011, when the S&P rating agency spooked global markets when it downgraded the US credit score from AAA to AA+, marking the first time in 70 years that the US treasury debt did not receive its highest rating from S&P.

China Equity Markets:

The AlphaShares China All Cap Index (Bloomberg: ACNACTR) added 5.26% in October following September’s gain of 6.59% in September to bring 2012 returns to 13.36% so far this year. China was the third-best performing country in the MSCI Emerging Markets Index this month, behind only Turkey (+10.39%) and Columbia (+5.91%) and well over the MSCI EM broad market’s return of -0.73%. While China H-Shares markets continue to rebound (the Hang Seng Index touched a 14-month high of 21,810 on October 15th), China A-Shares markets continue to struggle as the CSI 300 Index slipped -0.89% this month, bringing 2012 returns into the red at -0.83% YTD. The Hang Seng A-H Premium Index (HSAHP), an index used to trace the price premium (or discount) of A-Shares to H-Shares, closed October at 97.91 to mark the lowest monthly finish to a month in over two years. The index had traded as high as 141.44 as of September 2011, when the average dually listed stock in the index would trade over 41% higher in the Shanghai and Shenzhen exchanges compared to that of its listing at the Hong Kong Stock Exchange.

Small cap names fared better than their mega-cap peers, as the AlphaShares Small-Cap index (ACNSCTR) was up 8.03% while the FTSE China 25 Index gained 6.18% – bringing YTD returns to 11.41% and 9.80% respectively so far in 2012. All sectors in the AlphaShares All-Cap Index recorded gains this month, save Technology, on prospects that the new leadership will energize the economy. In particular, Industrials were the best performers (gaining 10.21% as a group), followed by Materials (+10.21%) and Financials (+8.01%). Seven of the eleven largest contributors to positive return this month hailed from the Financial Sector, with the Industrial and Commercial Bank of China (1398 HK) having the most impact, gaining 12.05% in October.

As mentioned, technology shares weighed adversely on index returns this month, as six of the eight largest detractors from index returns came from the sector. The AlphaShares China Technology Index (ACNITTR) fell -1.66% during October to stand at 4.26% YTD. Baidu.com (BIDU US), owner of China’s largest online search engine, dragged the most on index returns this month, as its ADRs traded off -8.73% following a lower-than-expected sales forecast at the end of the month. The company projects that revenues will rise as much as 42%, but would be the slowest revenue growth in three years.

Despite all the talk of a “Chinese Real Estate Bubble”, the AlphaShares China Real Estate Index (ACNRET) continues to chug along, gaining 7.47% in June. The Chinese government seems persistent in cooling local real estate prices, and one of its preferred methods is to increase the supply of housing. Real estate management and development companies make up 90.86% of the index, and have benefited immensely from such pro-building policies. The index is up 21.93% so far in 2012.

Longfor Properties (960 HK) was the largest contributor to Chinese real estate returns, gaining 14.05% this month. Co-founder and chairwoman Wu Yajun was once again named the richest woman and richest selfmade business woman in the world by the China-based Hurun Research Institute with estimated net worth of $6.1 billion USD. Chinese women take up 11 of the 22 spots, including four of the top five and seven of the top ten. Wu is well-known for her low-key approach to business, having largely adopted what is referred to as the "Three Nos" principle: no TV appearances, no interviews and no autographs. Longfor has extensive developments across various Chinese cities, including ordinary homes, high-end apartments and villas. Wu is said to have risen above the fierce competition through her attention to detail and relentless drive for perfection.

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.