Investing in China Frederick Jiang, CFA

Ways to Play China ADRs Local Shares in Hong Kong Index ETF Mutual Funds (Asia, China, Emerging Market) Multi-National Companies with Big China Exposure

Not for Faint Heart Volatility Can be Very High in Down Turn Less Transparency and Different Accouting Stick to Mid to Large Cap Names Be Patient

High Return, High Volatility

Consistent Earnings Growth Hang Seng China Enterprises Index - EPS

Buy Low, Sell High Hang Seng China Index – Price/Earnings Multiple

Opinions Diverged China will overtake the U.S. to become the world’s largest economy Jim O’Neil, Goldman Sachs

Opinions Diverged The real estate bubble in China, looks like Dubai times 1000 – or worse Jim Chanos

Looking Back – GDP in US$ CAGR 10.2% CAGR 2.9%

Looking Back – Stock Market

What drives China’s Growth? Reform and Restructuring Urbanization and Industrialization Demography Dividend and Education Savings and Capital Formation Globalization

Reform and Restructuring From Communist to Socialist with Chinese Characteristics From Central Planning to Market Driven Economy From Closed-Door policy to Open-Door Policy From Dictatorship to “Centralized Democratic” Decision Making Privatization

What Drives China’s Growth? Reform and Restructuring Urbanization and Industrialization Demography Dividend and Education Savings and Capital Formation Globalization

What Drive China’s Growth? Urbanization million per month Industrialization -- Raise productivity -- Monetize economic activities

Urban / Total Population (%) Australia China Hong Kong100 India Indonesia Japan Korea Malaysia Pakistan Philippines Singapore100 Thailand Vietnam Asia US Latin America Western Europe Source: United Nations, CLSA Asia-Pacific Markets

What Drives China’s Growth? Reform and Restructuring Urbanization and Industrialization Demography Dividend and Education Savings and Capital Formation Globalization

Demography and Education Demography Dividend China’s Baby-boomer Generation Young and Educated With money, Will spend College Enrollment

Brain power: US vs China Science and engineering PhDs Source: National Science Foundation, China National Bureau of Statistics, CLSA Asia-Pacific Markets

What Drives China’s Growth? Reform and Restructuring Urbanization and Industrialization Demography Dividend and Education Savings and Capital Formation Globalization

Saving is Virtue! Waiting to make deposit Total Deposit Total Household Deposit in China US$5.13 Trillion

Household Savings / Disposable Income Source: Euromonitor, CLSA Asia-Pacific Markets Higher Savings Ratio, Higher Capital Formation, Higher Growth Rate

What Drives China’s Growth? Reform and Restructuring Urbanization and Industrialization Demography Dividend and Education Savings and Capital Formation Globalization

China Accounts for 10% of Global Trade

Drivers for the Growth in Next Decade? Reform and Restructuring should continue, but no more low hanging fruits Urbanization and Industrialization another two decades to go Demography Dividend and Education no more labor growth, productivity to go higher Savings and Capital Formation need less savings to drive domestic consumption Globalization slower export growth, trade balance

No More Double Digit Growth

Power of Compounding Key Assumption China India U.S. Real GDP7%6%2% Inflation3%4%2% Currency Appreciation2%1%

Myth 1: Massive Real Estate Bubble “A reported 64 million empty apartments in China’s Ghost Towns” – Financial Times Blog “30 billion sf of office under construction, a 5-foot by 5-foot cubicle for every Chinese” – Jim Chanos “It costs you $1 million to buy an apartment in Beijing or Shanghai”

“Housing Bubble” in China Supply and Demand in Last 10 Years (in millions) Empty Complex

“Housing Bubble” in China Source: National Statistic Bureau

“Office Bubble” in China Myth: “30 billion square feet of office under-construction” Facts: 18 billion square feet all together, residential, office, commercial. Facts: office under-construction is 1.3 billion square feet, not 30 billion.

“Housing Price Bubble” in China Source: Merrill Lynch Economic Research Myth: $1 million apartment in Shanghai and Beijing Fact: Average price is 300K-400K in BJ and SH, and nation wide average price is less than $80,000 in urban area.

Chinese Cities are Quite “Small”

Another Angle: Mortgage Loan Size Mortgage to GDP: China 15%, US 82% Source: Merrill Lynch Economic Research

Myth 2: China is Export Driven

Gross Export vs. Net Value-Added Average Selling Price $400 Ex-Factory Cost: $200 (reported in China’s export) Value added in China: $6 (reported in GDP)

True Export Share Source: UBS Economic Research and Waddell & Reed Estimate

GDP Composition Source: Waddell & Reed Estimate

Myth 3: China is Investing Too Much Chinese Consumption as % of World Total Source: BNP Paribas Research

China’s Capital Stock Total Length of RailwayTotal Number of Airports Total Length of Paved Roads Number of Vehicles per 1000 People

Per Capita Steel Production

Capital Formation as % of GDP Source: CEIC

Where does the investment go? Manufacturing/Mining Infrastructure Build-out Property Development Other Services Source: China National Bureau of Statistic

What support investment growth? Source: CEIC

Myth 4: China’s Debt Bomb “As the world watches the Greek credit crisis unfold, a Sino-debt disaster is brewing halfway around the world.” Fortune Magazine, June 2011

Real Picture Estimated Government Liability and Asset (% of 2010 GDP) Assets Liabilities Market Value of Listed SOEs35% Central Government Debt17% Value of Other SOE Assets15% Local Government Debt27% Land Use Rights30% Legacy Bad Loans7% Total Gross Public Debt51% Under-funded Pension/Healthcare25% New Social Security Coverage5% Total Saleable Assets80% Total Liabilities81% Source: CEIC, UBS and Waddell & Reed Estimates

Public Debt -- U.S. vs China

Public Debt – U.S. vs China U.S.China Federal Government 93% 24% (17%+7%) State Government 7% 10% Local Government 11% 17% Gross Public Debt 111% 51% Medicare Shortfall 166% 25% Social Security shortfall 37% 5% Total Government Liabilities 314% 81% Note: Chinese data does not include debt owned by State Owned Enterprises. U.S. data does not include agency bonds.

Private Debt – China vs U.S. Mortgage to GDP: China 15%, US 82%

Not Without Road Blocks Less Favorable Demography Structural Inflation High Environment Protection Cost Imbalanced Economic Structure Widening Wealth Gap Difficulties in Political Reform Wide-Spread Corruption Instable Corporate Profit Margin No Equity Culture Many More…

Less Favorable Demography Aging Population Less number of young workers

Structure Inflation Food Price Inflation: the side-effect of urbanization Major driving force behind high CPI inflation Lack of Natural Resources: 60% of Oil Imported 50% of Iron Ore Imported 60% of Copper Concentrate 30% Soy Bean 5% of Corn ………

High Environmental Cost Pollutions Cost China as Much as 2-3% of GDP

Imbalanced Economic Structure U.S.China Personal Consumption70%34% Government Spending19%21% Investment15%33% Net Export-3%12% Total100%100%

Investment Implication China Offers Long Term Growth Opportunities Different Ways to Play China Not for Faint Heart

Investment Implication Key Assumption China India U.S. Real GDP7%6%2% Inflation3%4%2% Currency Appreciation2%1%

$10,000 Growth at Different Rate Assuming: 1. Chinese EPS grows at nominal GDP rate, US grows at 1.5X of GDP rate; 2. PE multiple and profit margin Stay the Same Over 10 Years.

Q & A