CHINA BEHIND THE MEDIA HYPE€¦ · western developed nations) handled the 2008 financial crisis. At a point when clear government intervention was required to save the financial

April 2016

1Proprietary and Confidential

®

CHINABEHIND THE MEDIA HYPE

Dianna Raedle, CEO

Proprietary and Confidential

2

Since founding Deer Isle, Dianna has raised approximately $5 billion in assets and has advised numerouscompanies and funds with regard to their strategy, structure and capital raising.

Prior to founding Deer Isle Group, Dianna co-founded Millennium Americas where she was a member of theInvestment Committee and was on the investment team. Millennium Americas was an advisor to MillenniumGlobal Investments Ltd., an ~$12 billion London based investment management company for the Millennium GlobalSpecial Situations Americas Fund (MGSS). Prior to Millennium Americas, Dianna had extensive experiencecreating highly structured transactions at ABN AMRO, and SBC Warburg Inc, where she was a Director and atCredit Suisse First Boston (London and Switzerland), where she was a Vice President.

Dianna is on the Board of Directors for the Harvard Business School Club of New York and is Board Emeritus forthe Harvard Business School Club of New York Community Partners program. In addition, she is a mentor andteaches a work shop for the Princeton University Keller Center for Technology and Entrepreneurship. She is alsoa 2011 winner of the International Women's Entrepreneurial Challenge, sponsored by the Manhattan Chamber ofCommerce.

Dianna has an MBA from Harvard Business School and a BA from Princeton University. She has Series 7, 24, 63,65, 79 and 99 Registrations.

Dianna Raedle is CEO/Founder/Managing Director of Deer Isle Group and is responsiblefor all activities, including investment management. Dianna has over 20 years of experiencein both public and private markets across the capital structure, specializing in emergingmarkets and special situations.

In 2012, Dianna identified an attractive investment opportunity in the Chinese onshore fixedincome market and has partnered with one of China’s largest asset managers to provideinstitutional investment management service to US/International investors who want toaccess the market. A China-focused fixed income strategy fund (“Deer Isle-Bosera RMBIncome Fund”) also has been launched to provide such access.


3

IntroductionChina’s Diversifying Macro ManagementChina Has Significant Relative ValueChina’s Sector GrowthImplication of China’s Growing Middle ClassIs China Going To Have A Destabilizing Default?Not Without RisksChina Currency OutlookAppendix

457

101214172023


4

INTRODUCTIONDear Investor:

Deer Isle has been doing independent research on China since 2012. During this time, we have developed strong

relationships with local financial market participants and when we read the media headlines, the headlines do not

reflect the reality that we experience.

We have written this paper to help you look beyond the headlines and to help you look at some of the more detailed

data that, in our minds, demonstrates the breadth of China’s financial system as well as the complexity that

supports its growth. We feel that China, despite its growing pains and sometimes awkward attempts to manage

growth amid competing agendas, will be a fundamentally solid investment destination with the rewards and risks

that are inherent in making investments.

Please let us know if we can answer any further questions as we would like to be your resource as you consider

making Chinese investments.

Sincerely,

Dianna Raedle

Source: The Economist, 04/26/2016

Source: WSJ, 04/16/2016

Source:Bloomberg,01/19/2016

Source: Bloomberg, 04/20/2016

Source: SCMP, 04/27/2016


5

CHINA’S DIVERSIFYING MACRO MANAGEMENTADDITIVE FOR AN INTERNATIONAL PORTFOLIO

One of the challenges for investors

analyzing China is understanding the

complexities of the Chinese economy

and the interplay of policy in an

economy where policy approach is

very different from a more familiar

western approach.

It is easy for the media/some

researchers to seize on sound bite data

when trying to create sales but creating

sound bites from a complex and large

economy such as China is too simplistic

to explain its success.

In the west, it has become accepted wisdom that monetary policy

is the most efficient way to manage an economy in order to create

the highest level of national wealth. This example, at its most

extreme, is evident in the way the United States (and other

western developed nations) handled the 2008 financial crisis. At a

point when clear government intervention was required to save the

financial system, the US chose to intervene with monetary policy

(i.e. quantitative easing) rather than by using fiscal policy (i.e.

“buying”/upgrading infrastructure such as bridges and airports).

US (monetary) intervention has been the largest the world has

ever seen with $4.25 Trillion of US Treasuries and MBS now on

the Federal Reserve’s balance sheet 1. This number does not

include Western Europe’s quantitative easing activities. These

purchases effected the yield curve, benefiting certain powerful

financial institutions as well as financial borrowers, and was

meant to trickle down to the rest of the economy.


6

In China, fiscal intervention has been the policy of

choice and this policy framework tends to make west-

ern investors nervous.

However, China has seen unprecedented growth: now

the largest economy in the world on a PPP basis and

second largest on an absolute basis; a rapidly growing

middle class surpassing the US (Figure 1) and a highly

diversified economy.

Investors, when analyzing investment in China, may

want to consider the benefits of China’s reliance on

fiscal policy rather than solely monetary policy as a way

of managing its economy since it is one of the few major

economies that is approaching a capitalistic economy

with a diversifying political approach. This approach can

mean investment diversification in an investment envi-

ronment when diversification is hard to find.

The net effect of different policy approaches can be

seen in China versus US growth cycles. China's growth

seems to be slowing (with some signs of pick up) while

the US is, hopefully, in a raising growth cycle. This

means that Chinese interest rates look to continue to be

stable or to decline while US rates will most likely contin-

ue to increase. If US rates do go negative as has been

recently discussed, the main reason will be

global/Chinese slowing growth.

Should China start to focus on monetary policy to man-

age its economy, then global correlations may become

even stronger than current correlations which would

make economic cycles that much more volatile – which

would be that much scarier for all global

investors/economies.

As of end of 2013.Source: “The Rise of China’s New Consumer Class”, Goldman Sachs Global Investment Research.

770

146167

73

0

100

200

300

400

500

600

700

800

900

China US

Pers

ons

in M

illio

ns

Figure 1: Working Population and Middle Class

Working Population Middle Class


7

Figure 2: Country Comparison

Country2 Year Govn’t

Yield a

Debt to GDPRatio b

CreditRating c

AnnualizedCurrency

Volatility d

China 2.24% 244% AA-(negative)

2.56%

US 0.87% 248% AA+u 8.02%Japan -0.23% 388% A+u 11.07%UK 6.00% 262% AAAu 9.20%Euro 11.47% Germany -0.49% 188% AAAu Italy 0.01% 275% BBB-u

CHINA HAS SIGNIFICANT RELATIVE VALUE RMB VERSUS SDR PEER CURRENCIES

The IMF has sent a strong signal that

China is approaching developed

nation status and is certainly no

longer an emerging market by

including China in the official SDR

basket. When China’s treasury yield

curve is analyzed against SDR peer

yields, it is clear that it offers the highest

available yield versus its peers. China

offers 2 - year yields of 2.24% which is

1.37% higher than the next highest

yielding SDR government bond which is

the US (Figure 2). In fact many of the

SDR government bonds offer close to 0

or negative yields including Italy which is

a country that not that long ago seemed

to be heading to default. Not only does

China offer higher yields than its SDR

peers but it has an attractive rating /debt

to GDP ratio of 244% (Figure 2).

The “holy grail” of investment theory is finding investments that

add diversification to a portfolio while having an attractive risk

adjusted return.

The correlation between SDR currency change and following

currency movement is statistically significant when the changes

have been a much smaller percentage change than the change

that is being made to make room for the RMB. The RMB is joining

the SDR basket at 10.92% of the basket and the previous largest

increase in a basket currency was under 4% (Figure 5).

a. Source: Bloomberg as of March 28, 2016.b. Source: Standard and Poor’s, as of June 2015 3.c. Latest credit ratings. Source: Standard and Poor’s.d. Based on daily exchange from Federal of St Louis from 04/01/2011 to 04/01/2016.


8

So, if historical correlations hold true, the RMB should

be expected to increase over the 6 months from when

the RMB joins the basket in October 2016. The correla-

tion of the SDR currency movement to other economic

measures such as GDP growth change or 3 month

interest rate is not statistically significant (Figure 6 and 7).

Investing in local currency Chinese government bonds

meets the criterion of having attractive risk adjusted

returns while being a source of diversified returns since

it has the lowest correlation to the US treasury market of

any of the SDR constituents while offering attractive risk

adjusted yields (Figure 3 and 4).

Given the substantial benefit of adding Chinese fixed

income to a fixed income portfolio from both a risk

adjusted basis and a correlation basis, we believe that

the risk of significant RMB depreciation is limited since

there will be a natural technical bid to the currency as

investors gain access to an attractive asset.

Based on historical returns of 2-year on the run government bonds, as of March 28, 2016..Source: Bloomberg.

Based on historical returns of 10-year on the run government bonds, as of March 28, 2016 .Source: Bloomberg.

Figure 3: China 2-year Government Bonds Have LowCorrelation to SDR Peers (2011 to 2016)

ChinaGvntBond

USGov’tBond

UKGovn’tBond

EuroGov’tBond

JapanGov’tBond

ChinaGov’tBond

1 0.16 0.16 0.06 0.06

US Gov’tBond

0.16 1 0.43 0.09 0.04

UK Govn’tBond

0.16 0.43 1 0.09 0.07

EuroGov’tBond

0.06 0.09 0.09 1 -0.01

JapanGov’tBond

0.06 0.04 0.07 -0.01 1

Figure 4: China 10-year Government Bonds Have LowCorrelation to SDR Peers (2011 to 2016)

ChinaGvntBond

USGov’tBond

UKGovn’tBond

EuroGov’tBond

JapanGov’tBond

ChinaGov’tBond

1 0.12 0.08 -0.01 -0.02

US Gov’tBond

0.12 1 0.85 0.55 -0.04

UK Govn’tBond

0.08 0.85 1 0.6 -0.07

EuroGov’tBond

-0.01 0.55 0.6 1 -0.02

JapanGov’tBond

-0.02 -0.04 -0.07 -0.02 1


9

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

-13.00% -8.00% -3.00% 2.00% 7.00% 12.00%

Wei

ghtin

g C

hang

e

Currency Change

Figure 5: 6-month Currency Movement after SDR Weighting Adjustment

Deutsche Mark (prior to Euro) French Franc (prior to Euro) Euro GBP Japanese Yen USD (DXY)Source: Weighting changes from IMF. Link: http://www.imf.org/external/np/fin/data/sdr_ir.aspx. Currency rate changes from Fed of St. Louis.

Source: GDP growth rate from Eurostat. Link: http://ec.europa.eu/eurostat/data/database. Currency rate change from Federal Reserve Bank of St. Louis.

Source: Interest rate change from Eurostat. Link: http://ec.europa.eu/eurostat/data/database. Currency rate change from Federal Reserve Bank of St. Louis.

10.92% Weighting of RMBInclusion in SDR

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

-10.00% -8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00%

GD

P G

row

th R

ate

Cha

nge

Currency Change

Figure 6: 6-month Currency Movement vs GDP Growth Change

Deutsche Mark (prior to Euro) French Franc (prior to Euro) Euro GBP Japanese Yen USD (DXY)

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

-10.00% -8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00%

Inte

rest

Rat

e C

hang

e

Currency Change

Figure 7: 6-month Currency Movement vs 3-month Interest Rate Change

Deutsche Mark (prior to Euro) French Franc (prior to Euro) Euro GBP Japanese Yen USD (DXY)


10

9.5%

46.1% 44.3%

1.4%20.6%

78.1%

9.0%

40.5%50.5%

1.6%

20.8%

77.6%

0.0%

20.0%

40.0%

60.0%

80.0%

Agriculture Industry Services Agriculture Industry Services

China US

Figure 8: GDP Breakdown by Sector(China vs US)

2011 2015

This change in GDP percentages is supported by the robustness

of non-manufacturing versus manufacturing PMI numbers.

China’s PMI numbers below 50 is a constant China headline from

the media. However, this only captures manufacturing PMI. Non-

manufacturing PMI has consistently been comfortably above 50

(most recent reading is 52.7, Figure 9). For a point of reference,

China’s PMI numbers are quite consistent with the US’s PMI

numbers (Figure 9 and 10). The Feb 2016 manufacturing PMI

being 49.5 in the US and 49 in China while Non-manufacturing

PMI in the US is 53.4 and in China 52.7 (Figure 10).

CHINA’S SECTOR GROWTHHELPS CREATE ECONOMIC STABILITY

China is in the process of changing

its economy from a manufacturing

economy to a services economy and

despite fearful western media headlines

that predict an economic crash based

upon the old manufacturing sectors,

China seems to be cautiously

engineering this transition. There are

several indicators which highlight China’s

success in making this transition. The

Services sector is now more than 50% of

GDP (Figure 8). The sector as a

percentage of GDP has grown by 6%

since 2011 which compares with the US

where the Services sector has remained

approximately the same percentage of

GDP over a similar time frame.

Source: China GDP breakdown from NBS; USD GDP Breakdown from CIA Factbook.


11

China’s PMI readings since inception in 2013, even

when growth was acknowledged to be strong and fiscal

policy tight, have consistently been approx. 50 for Man-

ufacturing and over 52 for Non-manufacturing so there

seems to be less correlation between PMI and absolute

growth than in other countries.

The transition from industry to services can be seen

more dramatically by looking at the percentage of Chi-

na’s GDP that is generated by each sector . The per-

centage of GDP that is generated by Industry has

declined by approx. 6% since 2011 with one third of the

decline occurring in the last year (Figure 8). The United

States in the meantime has maintained a very consistent

economic sector breakdown (Figure 8).

In analyzing sector growth further, it is possible to see

that the consumer service sector profitability continues

to grow at a robust pace (Appendix 1). Profits from

these sectors represent a total of approx $2 Trillion 4,

which compares with US corporate and financial profits

after taxes which equals approx. $5.3 Trillion 4. The ratio

of China profits to GDP compares favorably to the US

(approx. 20% for China/29% in the US) given where it is

in its development cycle.

50.052.054.056.058.060.0

2013

-02-

0120

13-0

4-01

2013

-06-

0120

13-0

8-01

2013

-10-

0120

13-1

2-01

2014

-02-

0120

14-0

4-01

2014

-06-

0120

14-0

8-01

2014

-10-

0120

14-1

2-01

2015

-02-

0120

15-0

4-01

2015

-06-

0120

15-0

8-01

2015

-10-

0120

15-1

2-01

2016

-02-

01

Figure 9: Non Manufacturing PMI (US vs China)

US China

45.047.049.051.053.055.057.059.0

2013

-02-

0120

13-0

4-01

2013

-06-

0120

13-0

8-01

2013

-10-

0120

13-1

2-01

2014

-02-

0120

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4-01

2014

-06-

0120

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8-01

2014

-10-

0120

14-1

2-01

2015

-02-

0120

15-0

4-01

2015

-06-

0120

15-0

8-01

2015

-10-

0120

15-1

2-01

2016

-02-

01

Figure 10: Manufacturing PMI (US vs China)

US China

Source: Bloomberg as of February 2016.

Source: Bloomberg as of February 2016.


12

IMPLICATION OF CHINA’S GROWING MIDDLE CLASS

WEALTH CREATION TO BUILD A SERVICE ECONOMY

China is in the midst of creating some

of the fastest growing wealth in any

country across both the middle class

and wealthy. This fast growth means

that the Chinese consumer is becoming

more sophisticated, looking for brands,

as well as being more focused on

purchasing leisure goods. As more

people have more disposable income,

China’s focus on using consumption and

services to grow its economy should be

an attainable goal.

China now represents $22,817B (almost 50%) of Asia-Pacific’s

total wealth of $45,958B and it was one of the only geographies in

the world that saw an increase in wealth between 2014 and 2015

(+7%) other than North America (+4.4%) using current exchange

rates 5. To the extent that China’s wealth growth continues to

outpace North America, the Chinese could well become the

world’s largest consumers by 2020. China has witnessed the

world’s highest real annual wealth growth rates from 2000 to 2015

(5.3%) when the world’s median growth rate was 2.0%. It is the

only country to have grown at a rate faster than 5% during this

time period 5.

Despite China’s reputation for income inequality, it has seen the

largest average increase in wealth of almost any geography

(Figure 11). China’s economic growth has raised economic well-

being for a rising middle class which is a great accomplishment

given the size and diversity of China’s population.


13

Figure 11: Regional Composition of GlobalWealth Distribution, 2015

According to the Goldman Sachs “China’s New Con-

sumer Class” research report, China’s working popula-

tion is larger than those of the US and Europe combined.

China has approx. 770mm workers while the US has

146mm (Figure 1). This enormous difference in number

of workers means that Chinese workers only need to be

20% as efficient as US workers for China’s economy to

supplant the US as the largest global economy in USD

terms. Currently, only 11% of China’s population can be

considered middle class – so, the economic growth that

China has seen is just the beginning. However, given

the size of China’s population, China’s middle class

(146mm people) is approx. the same size as the US’s

working population.

Goldman divides China’s workers into 4 tiers (Figure

12). To the extent that that each of these groups is able

to increase their income in line with low estimates of

economic growth (i.e. 5%) with Urban Middle increasing

at a faster rate (10%) given they are upwardly mobile -

this would be a gross income increase of $297B which

represents 2.9% of GDP. This income effect on GDP

does not include the multiplier effect. Importantly, in

2015, the Chinese (55%) remain confident that their

household income will increase significantly over the

next 5 years (Figure 13).

However, there are differences between cities as well as

regions. For instance, consumer confidence - “70% of

consumers in the Xiamen-Fuzhou city-cluster, which lies

on the coast across from Taiwan, say they are confident

their income will significantly increase over the next five

years. The Shandong-Byland city-cluster, which lies on

the coast between Beijing and Shanghai, is compara-

tively pessimistic, with only 33% of its consumers ex-

pressing the same level of confidence.”6

China’s increase in income has resulted in a corre-

sponding increase in overall well-being. On many of the

quality of life indicators that the World Bank tracks,

China compares favorably with a small lag to the US

(Figure 14).

Source: Credit Suisse, “Global Wealth Report 2015”.

Source: Goldman Sachs, “The Rise of China’s New Consumer Class”, October 15, 2015.

57% 55%

32% 30%

0%

10%

20%

30%

40%

50%

60%

China, 2012 China, 2015 United States, 2011 United Kingdom, 2011

Figure 13: Percentage of respondents strongly agree or agree their household income will increase significantly over the

next 5 years

China, 2012 China, 2015 United States, 2011 United Kingdom, 2011

Source: McKinsey&Company, “The Modernization of the Chinese Consumer”, March 2016.

Source: World Bank.

Figure 14: Quality of Life IndicatorsUS China

Population (Billion, 2014) 318 1,357Population Growth (2014) 0.70% 0.50%Life Expectancy (yrs, 2014) 78.8 75.4Military Expenditures (% of GDP 2014) 3.50% 2.10%Gross enrollment, secondary (2013) 0.94 0.924Mortality Rate, under 5 (per 1000, 2015) 6.5 10.7Mobile Subscription (%, 2014) 98.4 92.3Time Required to Start a Business (day) 5.6 31.4

Figure 12: 4 Tiers of Chinese WorkersPopulation

(mm)Annual Incomeper Capita ($)

Movers & Shakers 1.4 $500,000Urban Middle 146 $11,733Urban Mass 236 $5,858Rural Workers 387 $200


14

IS CHINA GOING TO HAVE A DESTABILIZING DEFAULT?HIGHLY UNLIKELY

It seems highly unlikely that China will

suffer from a major default since China

seems to have at least as many

resources at its disposal as the US had

in 2008 (i.e. monetary policy that can

immediately be implemented) and it

seems to have additional tools that the

US did not have (i.e. ability to use fiscal

policy, control capital and control other

regulatory levers such as residential

home purchase down payments).

China doomsayers keep predicting that China’s economy will

suffer a major default. Of course one can never say never - look

at the US in 2008 and never is a long time.

Therefore, it seems the appropriate question to ask is whether it is

likely that China’s economy will suffer a major default any time in

the near future.

China’s current debt to GDP ratios are in line with or lower than

other major economies, especially its SDR peers (Appendix 2).

Perhaps more telling than a revenue to debt analysis is an asset

to debt analysis. China’s assets to debt ratios are very high

especially when compared with the US. Since, China, as a

government owns most assets, it has a lot of financial flexibility

when it comes to managing its balance sheet.

China actually has a positive Net Asset position (+USD 4.4

Trillion) while the US has a negative Net Asset Position (-USD

17.7 Trillion). In terms of the worry that China has sold all of its

land, land is valued at USD10.1 Trillion on its balance sheet and

proceeds from land sales are valued at USD 0.6 Trillion (Figure 15

and 16).


15

The State Owned Enterprises (“SOEs”) in China also

have a positive net worth and net income. So, even

though they are less efficient, they still have a net

positive impact on the economy (Figure 17).

China not only compares well with the US but it also

compares well against the rest of the world. In the

OECD National Account statistics data base, China has

a financial net worth of +13.8%, giving it a ranking of 7;

while the US has a financial net worth of -98.91% giving

it a ranking of 27 (Appendix 3). This asset ratio analysis

seems to indicate that China has a deep reserve of

assets to offset any potential significant credit problems.

One area of asset quality concern is with the banking

sector. There is general consensus that losses are

being hidden on bank’s balance sheets. This is probably

because much of the lending is from state owned finan-

cial institutions to state owned enterprises, so it is easy

to imagine that the Chinese government does a calcula-

tion to maintain company liquidity and manage growth

declines by extending credit terms. However, since

many of the creditors have reasonable balance sheets,

the long run implication of this financial technique may

not be as severe as when there are limited assets.

In addition, Chinese banks have reasonable Loan Loss

Reserves, ROE and Loan/Deposit Ratios signaling that

there are reasonable assets and low cost funding to

offset potential problems. For instance, China’s Loan

Loss Reserve/Loans ratio was 3.03% and Loan Loss

Reserves /Non-Performing Loans was 181.18% in 2015

Q4 compared with 1.29% and 79.60% for the US re-

spectively. And, China’s Loan to Deposit Ratio was

67.24% versus 82.91% for the US reflecting a high

degree of low cost deposit funding for Chinese banks

(Appendix 4).

China is well aware of the dramatic increase of corpo-

rate leverage and has started the deleveraging

As of end of 2014. Source: China Academy of Social Sciences, “China National Balance Sheet 2015 Report”.

As of December 31, 2015. SOEs include central and local government SOEs, excluding financial institutions.Source: State-owned Assets Supervision and Administration Commission of the State Council website.

a. Assets and liabilities include US government and GSEs, as of end of 2014. Source: US GOVERNMENTNUMBERS FROM Department of the Treasury, page 48 of “Financial Report of the United StatesGovernment, Fiscal Year 2014”; GSEs numbers from Fed, page 99 of “Financial Accounts of the US”.

Figure 15: Chinese Government Balance SheetTrillion USD

Assets $35.00 Not for Immediate Liquidation $12.10 Public Utilities $2.10 Land $10.10 Proceeds from Sell of Land $0.60 For Immediate Liquidation $23.50 SOEs (non financial) $18.40 Policy Banks $2.40 Other Financials $2.70Liabilities $19.10Net Assets $15.90Net Assets Available for Liquidation $4.40

Figure 16: US Government Balance Sheet a

Trillion USDAssets $9.50 Govn’t Sponsored Enterprises $6.40 Accounts Taxes Receivables $0.26 Loans Receivables, net $0.10 TARP direct loans/equity invst $1.12 Inventories/related property, net $0.02 PPE, net $0.32 Debt and equity securities $0.88 Investment in GSEs $0.12 Other Assets $0.10Liabilities $27.20Net Assets ($17.70)

Figure 17: China Aggregated SOE Balance Sheets andIncome Statements, ($ Trillion, 2015)

Total Assets $18.40Total Liabilities $12.20Total Equity $6.18Revenue $7.00Expense $6.56Net Income $0.36Tax $0.59


16

process by prudently allowing more defaults (especially

in the sectors that have excessive production capacity,

i.e. energy, mining, steel sectors) before it accumulates

to a unsustainable level. To date there has still only

been 13 credit defaults 7 representing 0.3% of the total

credit market of 4102 credit bonds 8. Credit differentia-

tion is occurring in the local market, which is believed to

be beneficial to the economy by the government and is

embraced by the local market players.

Local Government Financial Vehicle bonds (LGFVs,

classified as corporate debt), are also closely monitored

by the government. In 2014, China initiated a national

audit of central and local government debts and then

allowed local governments to issue local government

bonds that are direct obligations in a swap for the LGFVs.

According to a special report conducted by National

People’s Congress, as of end of 2014, the stock of local

government debt was 15.4 trillion RMB (54% bank loans

and 8% bonds), main debtors being LGFVs (3.2 trillion

RMB had been swapped as of end of 2015), local

governments, government agencies and state-owned

enterprises 9. The aggregated debt to income ratio was

only at 86%, a manageable level with some local gov-

ernments debt to income ratio exceeding 100%9.

By increasing transparency and rolling over the off-bal-

ance-sheet debt into direct liabilities (typically with lon-

ger maturities) that is directly supported by the local

government credit, China believes the local govern-

ments financing cost will continue to decline. China is

closely monitoring the LGFVs swap program and the

overall leverage level of the local governments.


17

How much can Chinese data be trusted? It seems to be quite

clear that data from China gets manipulated. Whether it is GDP

growth or other economic indicators, it is hard to judge whether

the numbers are completely reliable. A simple analysis of GDP

sector growth seems to indicate that the overall GDP number is

overestimated. How is it possible that no sectors(Figure 18) show

negative growth even though some industrials, such as mining

are slowing considerably.

Figure 18: GDP Growths and BreakdownSector Name YOY GDP Growth

GDP 6.90% Agri, Forestry, Pasturage/ Fshry 4.00% Industrial 5.90% Construction 6.80% Wholesale and Retail 6.10% Transportation, warehousing 4.60% Hotel, Food and Beverage 6.20% Financial 15.90% Real Estate 3.80% Other Service 9.20%

NOT WITHOUT RISKS

CHINA’S ECONOMY & REFORMSAs with any economy, China’s

continued economic rise is subject to

many risks. The risks that are unique to

China are those which are linked to

government’s untested role. Since

international access to China’s capital

markets is tightly controlled, the risks that

China is incurring are mostly risks that

hurt China’s own population. Given that

the Communist party stays in power by

maintaining economic well-being, it is

quite clear that the Chinese will do

everything in their power to maintain

financial stability. One trader saying is

“Don’t bet against the Fed”. Perhaps

another is “Don’t bet against China”.

For the year of 2015. Source: China NBS.


18

Since the GDP numbers are unreliable, the real ques-

tion, seems to be one of order of magnitude. If China’s

growth is not 7% - what is a reasonable estimate and

does this estimate indicate severe economic troubles.

We believe that growth above 5% is still a good estimate

and we believe that this growth rate is consistent with a

stable economic framework. We believe that this growth

represents a stable economic framework since it is hard

to imagine a country with GDP as large as China’s

continuing to be able to grow at a 7 to 10% rate when

developed nations are lucky to see 3% growth rates.

Political and regulatory risk is another concern espe-

cially given the manner in which stock market volatility

has been handled. In our mind, the largest factor for

international concern is the unknown of short term Chi-

nese government actions as they try to control their

multiple levers to manage their growth. We believe that

China’s long term goals are firmly towards a market

economy. China’s goals are a market economy since

they believe a capitalistic approach supports economic

growth which supports the power of the Communist

Party. Therefore, we believe that China will not do any-

thing to fundamentally alter market driven forces. How-

ever, we also believe that there will continue to be short

term volatility as China learns how investors react to

their economic management.

China’s debt has been increasing at a faster rate

than other countries 10. China had a lower base from

which to start so it is natural that its debt to GDP has

grown substantially as China tries to maximize growth.

Like Japan, most of China’s debt is held internally so it

can manage the debt. It’s savings rate is one of the

highest in the world (even exceeding Japan) and its

external debt service is 1.9 % of exports/etc is also very

low 11. So, one of the big questions is whether China can

control its debt to GDP increase over the long term to a

level that is below its GDP growth such that its Debt to

GDP ratio remains consistent with other large econo-

mies.

Will SOEs be reformed enough to maximize growth.As stated above, SOE’s own a tremendous number of

assets and are responsible for positive economic

growth. However, SOE profitability is well below eco-

nomic growth targets and these institutions need to be

reformed in order for economic resources to maximize

utility. About 150,000 SOEs control over RMB 100 trillion

($15 trillion) of assets in China, which, in aggregate and

excluding financial institutions, returned 2.4% on assets

as of 201412. This compares with ROAs of 3.1% for

Chinese listed companies (excluding financial institu-

tions) and 6.4% for US companies (excluding financial

institutions)10.

One idea that the Chinese government has had is to

consolidate SOE’s so that they become more interna-

tionally competitive and focus on competing in the global

markets rather than in the home markets. So, far, this

idea has been slow to be implemented and seems to not

address fundamental inefficiencies.

It might be argued that in the Chinese context, where the

government is concerned about the well-being of the

masses rather than the capitalist class, China may, for

the foreseeable future, have lower economic efficiency

as measured by indicators such as ROA and ROE.

However, since the country still has significant develop-

ment potential as the rural population continues to ur-

banize, overall wealth generation will still be higher than

in most other countries even with lower productivity. In

order for China be able to continue it's above developed

market growth as basic industrial transformation slows,

SOE/company productivity will either be a big opportuni-

ty or an opportunity lost (middle income trap).


19

China’s demographics and investment in humancapital lags other countries. Given China’s easy ac-

cess to human capital and need to maintain employ-

ment, increasing productivity has not been a major goal

of an investment led economy. As China moves to a

consumption led economy, it will become important to

increase productivity and disposable income.

Perhaps surprisingly, China spends relatively little on

education as a percentage of GDP (Figure 19). And,

relatively few Chinese pursue higher education (Figure

20). China is trying to address the education deficit

especially as it relates to bridging the skills gap between

manufacturing and services as well as increasing pro-

ductivity. To this end, China is implementing a program

of “community colleges” to try to educate the rural popu-

lation that is moving to the cities in order for them to be

skilled for urban services jobs.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

S Africa India China Indonesia British Germany* Japan Russian Turkey USA

Figure 20: Enrollment in Tertiary Education

5.8%5.5%

5.2%4.8%

4.1%3.8%

3.6%

5.5%

0%

1%

2%

3%

4%

5%

6%

7%

British(2011)

France(2012)

USA(2011)

Germany(2011)

Italy(2011)

Japan(2013)

China(2014)

Japan(1989)

Figure 19: Working Population and Middle Class

Data as of 2014.Source: Goldman Sachs, page 51 of “Wall In: China’s Great Dilemma”.

Data as of 2013. The total enrollment in tertiary education, regardless of age, is expressed as a percentageof the total population of the 5-year age group following on from secondary school leaving.*Data as of 1991 instead of 1973.Source: World Bank, retrieved from Goldman Sachs, page 54 of “Wall In: China’s Great Dilemma”.


20

Given China’s enormous control over its capital system, China

can use various levers to implement their position of currency

stability. One of the most immediate levers China has is its

reserves. Even though China had been using the reserves to

support their currency, they still have the largest international

reserves ($3.2 Trillion) in the world. These reserves far outweigh

the second largest country which is Japan with $1.2T of reserves

or the US which has $118B (Figure 21).

Not only does China have very large financial reserves, it also has

been purchasing valuable non-financial assets.

CHINA CURRENCY OUTLOOK

STABLE TO APPRECIATING / MORE VOLATILE THAN IN PASTChinese authorities have made itclear that they want a stable currencyand given Chinese resources itseems highly probable that China willbe able to manage its currency.As noted in the SDR section, we believethat China offers significant relative valueagainst its SDR peers which shouldmaintain a financial bid for the RMB. Inaddition, there are other indicators thatalso make us believe that the currencywill be stable to appreciating. Currencyvaluations are not just fundamental butthey are also political. Ever since the“devaluation” in 2015, Chinese officialshave very consistently made it clear thatthey are not interested in significantdevaluation. These statements have evenbeen made very recently (Appendix 5,List of PBOC Statements about CurrencyStability).

As of end of January, 2016. Source: IMF, International Reserves and Foreign Currency Liquidity.

Figure 21: Financial Reserves (China vs US)2015 (Billion USD) US China

Official Reserve Assets 118 3,510 Foreign Currency Reserves 39 3,231 IMF Reserve Position 18 4 SDRs 50 10 Gold 11 64 Other Reserve Assets 0 -0.21 Other Foreign Currency Assets 0 202


21

China’s non-cash reserves of Oil and Gas, as well as

production of Gold, Silver, Copper, Rare Earths, Titani-

um, Lithium and Platinum, makes it competitive (and

often outstripping) to the US for these commodities.

China’s proven oil reserves (at $40/barrel) would add

almost $1 Trillion to its financial reserves (Appendix 6).

China has reduced using its reserves to support its

currency since it has implemented regulatory changes to

its system.

One of the reasons that Chinese officials are less con-

cerned about RMB depreciation is that Net Exports only

contribute approx. 2.7% to Chinese GDP (Figure 22).

China is a large processing country so weaker currency

hurts manufacturing inputs as much as it helps exports.

In March, China capital flight started to reverse (Figure

23). There is much anecdotal evidence that the Chinese

government has cracked down on capital flight leakage

and has been focused on stopping systems that have

been set up which allowed Chinese residents to circum-

vent capital rules in allowing capital to leave the country.

China believes that its currency strength should be tied

to its current account surplus that has only been growing

and, which demonstrates fundamental demand for its

currency. The Chinese believe that this fundamental

demand for their currency should be a better indicator of

their currency’s strength than rising or falling interest

rates. China’s Current Account Surplus as 2.7 % of GDP

compares very favorably to the US’s persistent current

account deficit (Figure 24).

This focus on current account surplus to gauge demand

makes additional sense within the context that China

has the highest real yields within its SDR peer group.

Even though US rates have increased and are expected

to continue to increase, the US still has negative real

interest rates. And, even though China’s interest rates

have been decreasing, it still has significant and com-

paratively high real rates, which makes it even a greater

relative value investment when compared with its SDR

peers (Figure 25 and 26).

Figure 24: Annual Current Account to GDPUS China

2006 -6.00% 8.50%2007 -5.10% 10.10%2008 -4.70% 9.30%2009 -2.70% 4.90%2010 -3.20% 4.00%2011 -3.10% 1.90%2012 -2.70% 2.60%2013 -2.40% 2.00%2014 -2.20% 2.10%2015 -2.70% 2.70%

49.10% 50.20% 50.80% 51.00% 51.40%

47.20% 47.30% 46.50% 46.50% 45.90%

3.70% 2.40% 2.50% 2.50% 2.70%

0%

10%20%

30%40%

50%60%

70%80%

90%100%

2010 2011 2012 2013 2014

Figure 22: China GDP Breakdown

Final Consumption Expenditure Gross Capital FormationNet Exports of Goods and Services

-$120-$100-$80-$60-$40-$20$0$20$40

$2,800$2,900$3,000$3,100$3,200$3,300$3,400$3,500$3,600$3,700$3,800$3,9001/

1/20

15

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Billio

n U

SD

Billio

n U

SDFigure 22: China Capital Outflow Stabalized

Starting February 2016

China Foreign Exchange ReservesChina Foreign Exchange Reserves Net Change

As of 2014. Source: United Nations, National Accounts Main Aggregates Database.

As of March 31, 2016. Source: Bloomberg.

As of 2015. Source: China data from SAFE, retrieved from Trading Economics. US data from Bureau ofEconomics Analysis, retrieved from Trading Economics.

Figure 23:


22

As US interest rate increase expectations moderate, it

can be expected that many of these currencies will, at a

minimum, stabilize versus the USD, and, perhaps, start

to appreciate. Should they start to appreciate, there is a

good chance that the RMB will also start to appreciate

(Figure 27 and 28).

Summary: In China’s drive to control its own desti-ny, delinking the Chinese economy to global vaga-ries is an important goal and one which can beachieved if the Chinese economy is able to switch tobe consumption oriented.

Given that Chinese political will, population wealthand development stage are closely aligned, we be-lieve that if any country can navigate the uncertainwaters of change, China will be that country.

9092949698

100102104106

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Figure 27: CNY Currency Rate vs CFETS, BIS and SDR Baksets

CFETS Basket BIS Basket SDR Basket

-2

-2

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%

Figure 26: China vs SDR Countries Core Inflation Rate

China Core CPI YOY Change US Core CPI YOY ChangeJapan Core CPI YOY Change Euro Core CPI YOY ChangeUK Core CPI YOY Change

-3

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Figure 25: China vs SDR Countries Real Interest Rate

China Real Interest Rate US Real Interest RateJapan Interest Rate Euroarea Real Interest RateUK Real Interest Rate

Real Interest rate is calculated by 2 year government bond yield minus core inflation rate.Source: Bloomberg as of February 29, 2016.

Source: Bloomberg as of February 29, 2016.

Source: CFETS of PBOC, as of April 08, 2016.

Source: Bloomberg, as of February 29, 2016.

80%

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Figure 28: CNY Currency Rate vs CFETS Currency(Assume 1 CNY = 1 Foreign Currency on Aug 31, 2015)

USDCNY EURCNY JPYCNY HKDCNY AUDCNY GBPCNY SGDCNYCADCNY CHFCNY NZDCNY MYRCNY RUBCNY THBCNY


23

Appendix 1: China Profit Growth by Sector

Industry (sort by % profit growth from 2014 to 2015)% growth from

2014 to 2015% of AnnualProfit 2015

% of AnnualProfit 2014

Petroleum Processing, Coking and Nuclear Fuel Processing 966.80% 0.50% 0.08%Water Production and Supply 41.50% 0.10% 0.09%Metal Products, Machinery and Equipment Repair 37.60% 0.00% 0.03%Other Manufacturing 19.90% 0.10% 0.10%Chemical Fiber Manufacturing 15.20% 0.20% 0.21%Furniture Manufacturing 14.00% 0.40% 0.34%Electricity and Heat Production and Supply 13.80% 3.70% 3.27%Electricity, Heat, Gas and Water Production and Supply 13.50% 4.20% 3.66%Pharmaceutical 12.90% 2.10% 1.79%Electrical Machinery and Equipment Manufacturing 12.10% 3.50% 3.05%Food 9.10% 1.40% 1.31%Chemical Materials and Products 7.70% 3.60% 3.20%Wine, Soft Drinks and Refined Tea Manufacturing 7.50% 1.40% 1.24%Cultural, Education, Arts, Sports, and Entertainment Products 7.40% 0.70% 0.62%Agro-food Processing 6.40% 2.50% 2.37%Paper and Paper Products 6.20% 0.60% 0.54%Instrument Manufacturing 6.10% 0.60% 0.53%Railway, Shipping, Aerospace and Other Transport Equipment 6.10% 0.80% 0.74%Computer,Communications/Other Electronic Equipment 5.90% 3.40% 2.99%Textile 5.10% 1.70% 1.60%Printing and Publishing 5.00% 0.40% 0.40%Non-metal Mining 4.90% 0.30% 0.30%Leather, Fur, Feather, Related Products and Footwear 4.90% 0.70% 0.68%Fabricated Metal Products 4.70% 1.70% 1.55%Rubber and Plastic Products 4.60% 1.50% 1.38%Textile and Garment, Apparel 4.00% 1.00% 0.96%Wood, Processing Wood, Bamboo, Cane, Palm Fiber/Straw 3.40% 0.70% 0.64%Manufacturing 2.80% 43.70% 41.51%Waste Reprocessing 2.60% 0.20% 0.14%Gas Production and Supply 1.50% 0.30% 0.30%Automobile 1.50% 4.80% 4.63%General Equipment Manufacturing -0.60% 2.40% 2.33%Tobacco -1.40% 1.00% 0.94%Specialised Equipment Manufacturing -3.40% 1.60% 1.67%Other Mining -6.70% 0.00% 0.00%Non-metallic Mineral Products -9.00% 2.80% 3.03%Non-ferrous Metal Smelting and Rolling Processing -11.00% 1.10% 1.15%Non-ferrous Metal Mining -19.30% 0.40% 0.44%Mining Support Activities -24.30% 0.00% 0.04%Ferrous Metal Mining -43.90% 0.40% 0.62%Mining -58.20% 2.00% 4.83%Coal Mining & Washing -65.00% 0.30% 0.98%Ferrous Metal Smelting and Rolling Processing -67.90% 0.40% 1.27%Oil and Gas Extraction -74.50% 0.60% 2.44%

Source: China NBS as of December 31, 2015, retrieved from WIND.


24

Appendix 2: Total Debt to GDP Ratios of Largest Mature Economics & PIIGS Countries

Country Government Household CorporateTotal Debt to

GDP Savings to GDPNet Debt to

GDPJapan 220% 66% 102% 388% 22% 366%Portugal 140% 79% 122% 341% 15% 326%Netherlands 74% 112% 128% 314% 29% 285%Greece 162% 63% 66% 291% 11% 280%France 109% 56% 125% 290% 20% 270%Spain 108% 70% 106% 284% 21% 263%Italy 153% 43% 79% 275% 18% 257%Canada 73% 95% 109% 277% 21% 256%UK 106% 86% 70% 262% 12% 250%USA 98% 79% 71% 248% 18% 230%Singapore 103% 61% 84% 248% 47% 201%S Korea 41% 86% 105% 232% 35% 197%China 43% 38% 163% 244% 50% 195%Germany 79% 54% 55% 188% 27% 161%

Source: Standard & Poor's Ratings Services, "Global Corporate Credit: Debt Has Outpaced Income Growth Since 2009", January 13, 2016


25

Appendix 3: Government Financial Net Worth as a percentage of GDPNorway 248.25%Finland 54.02%Luxembourg 46.19%Republic of Korea 30.57%Estonia 30.52%Sweden 19.25%China 13.80%Chile -0.75%Denmark -4.85%Australia -9.46%Turkey -16.66%Czech Republic -17.09%Slovenia -19.07%Slovakia -35.09%Poland -38.14%Netherlands -43.31%Germany -46.00%Iceland -48.80%Canada -53.83%Israel -55.70%Austria -59.31%Hungary -71.36%France -73.65%United Kingdom -81.11%Ireland -81.61%Spain -82.47%United States of America -98.91%Belgium -100.24%Portugal -108.01%Italy -131.50%Greece -132.68%

As of 2014. Source: OECD National Accounts Statistics (database); Eurostat Government finance statistics (database), except for China. China’s data from "Chinese Government Balance Sheet: 2010 - 2014" report,released by National Natural Science Foundation of China.


26

Appendix 4: Financial Indicators of Banking Industry (China vs US)Country 2015 Q4 2015 Q3 2015 Q2 2015 Q1

Loan Loss Reserve/Loans US 1.29% 1.31% 1.36% 1.38%China 3.03% 3.04% 2.98% 2.96%

Loan Loss Reserve/NPL US 79.60% 86.95% 85.89% 87.57%China 181.18% 190.79% 198.39% 211.98%

Loan/Deposits Ratio US 82.91% 83.88% 83.63% 83.76%China 67.24% 66.39% 65.80% 65.67%

Net Interest Margin US 2.95% 2.94% 2.95% 2.92%China 2.50% 2.50% 2.50% 2.50%

Capital Adequacy Ratio US 13.81% 13.80% 14.15% 13.70%China 13.45% 13.15% 12.95% 13.13%

Source: US banks ratios from Bloomberg as of 4Q, 2015 (for 23 large commercial banks). China data from China Banking Regulatory Committee website as of 4Q, 2015


27

Appendix 5: List of PBOC Statements about Currency Stability

"RMB will remain stable at its equilibrium level and will not depreciate in long term nor has the fundamental to

support huge depreciation. China will not use depreciation to stimulate exports…" - by Keqiang Li, Premier of

China in Boao Forum for Asia 3/24/2016

"China will not depreciate RMB to stimulate export, which is not beneficial to structural economic reform…. China

will keep RMB relatively stable at equilibrium level under the current managed floating regime" - by Keqiang Li,

Premier of China in meeting with managing director of IMF, Christine Lagarde 03/21/2016

"China's currency valuation should depends on trade balance and more fundamental factors (account has been

surplus over the past 10 years)… We expect the trend of reverting back to normal valuation level to continue

(after last-year-end capital outflow and deprecation)" - Xiaochuan Zhou, Head of PBoC, 03/12/2016

"It is not over to stress important thing by three times: The basis for long term RMB depreciation doesn't exist!

China doesn't intend to initiate currency war nor stimulate export via currency depreciation, which will hurt other

economics and is not beneficial to ourselves." - by Keqiang Li, Premier of China in meeting with Jacob Lew, US

Head of Treasury Department, 02/29/2016

Jacob J. Lew, Treasury secretary in the United States, and other finance ministers said that they accepted

China’s assurances that its devaluations had been part of a decision to let markets play a greater role in deciding

the value of the renminbi, and not an effort to gain an advantage in trade. “I think the communication that China

has done these past days has helped not just ourselves but all observers to understand that more clearly, and I

think that’s very positive,” - Jacob J. Lew, Treasury secretary of the United States in G20 Conference, 02/26/2016

“In the medium and long term, RMB can be expected to be stable at an equilibrium level……the introduction of

CFETS basket will be beneficial to better maintain the currency stability by setting a basket as reference ” - PBoC

press release on its official website on 12/14/2015

“China’s economy is maintaining relatively rapid growth. Goods surplus is still large. FDI and ODI are constantly

growing. The foreign exchange reserve is still sufficient. These factors mean there is no basis for continued

depreciation.” – Yi Gang, Deputy President of PBOC/Head of State Administration Foreign Exchange,12/1/2015


28

Appendix 6: Natural Resources (by Reserve or Annual Production) by Countries a

Rank CountryOil (Million

Barrels) Rank Country Gold (Kg) Rank Country Silver (Kg)1 Venezuela 298,400 1 China 428,000 1 Mexico 5,821,0012 Saudi Arabi 268,300 2 Australia 265,000 2 Peru 3,674,2833 Canada 172,500 3 USA 228,000 3 China 3,670,2104 Iran 157,800 4 Russia 213,977 4 Australia 1,840,0005 Iraq 144,200 5 South Africa 159,724 5 Russia 1,412,1006 Kuwait 104,000 6 Peru 151,486 6 Bolivia 1,288,0007 Russia 103,200 7 Canada 124,054 7 Chile 1,173,8458 UAE 97,800 8 Mexico 117,848 8 Poland 1,100,0009 Libya 48,360 9 Ghana 90,510 9 USA 1,090,00010 Nigeria 37,070 10 Brazil 79,563 10 Kazakhstan 963,58011 USA 36,520 11 Uzbekistan 73,00012 Kazakhstan 30,000 12 Indonesia 59,06613 Qatar 25,240 13 PNG 56,03514 China 24,650 14 Colombia 55,745

Rank CountryRare Earth(Tonnes) Rank Country

Lithium(Tonnes) Rank Country

Natural Gas(Million m3)

1 China 95,000 1 Australia 421,000 1 Iran 34,020,0002 Russia 7,485 2 China 61,000 2 Qatar 25,070,0003 USA 4,000 3 Chile 60,646 3 Turkmenistan 17,500,0004 Malaysia 261 4 Zimbabwe 44,000 4 USA 8,734,0005 Brazil 200 5 Portugal 19,940 5 Saudi Arabia 8,235,0006 Malaysia 97 6 Argentina 12,500 6 UAE 6,089,0007 India 0 7 Brazil 7,000 7 Venezuela 5,562,000

8 USA 1,500 8 Nigeria 5,118,0009 Algeria 4,505,00010 China 3,300,000

Rank CountryCopper

(Tonnes) Rank CountryTitanium(Tonnes) Rank Country Platinum (Kg)

1 Chile 5,776,000 1 Canada 2,800,000 1 South Africa 137,0242 China 1,600,000 2 Australia 1,340,000 2 Russia 84,0003 Peru 1,375,641 3 South Africa 1,120,000 3 South Africa 76,0084 USA 1,220,000 4 China 1,100,000 4 Russia 25,0005 Australia 996,000 5 Norway 826,126 5 Canada 16,0006 DR: Congo 914,600 6 India 750,000 6 USA 12,5007 Zambia 763,805 7 Mozambiq 720,100 7 Canada 9,0008 Russia 720,000 8 Vietnam 606,000 8 Zimbabwe 8,0009 Canada 631,856 9 Ukraine 600,000 9 USA 3,70010 Indonesia 509,000 10 Madagascar 562,000 10 Russia 2,60011 Mexico 480,124 11 Australia 430,000 11 Colombia 1,50412 Kazakhstan 442,200 12 USA 300,000 12 China 140013 Poland 428,879 13 Australia 230,000 13 Botswana 1337

a) For Oil and Natural Gas, the numbers are for reserves. For other resources, the numbers are for annual production.Source: Oil and Natural Gas Reserve from CIA, the World Factbook, as of January 2015. Other non-cash reserves from Minerals UK, as of 2014 (or earlier years if 2014 data not available).


29

Endnotes:

1. Federal Reserve Bank of New York, Factors Affecting Reserve Balances, released on Mar 31, 2016. Link:https://www.federalreserve.gov/releases/h41/20160331/.

2. Goldman Sachs, The Rise of China’s New Consumer Class, October 15, 2015 Link:http://www.goldmansachs.com/our-thinking/macroeconomic-insights/growth-of-china/chinese-consumer/.

3. Standard & Poor's Ratings Services, "Global Corporate Credit: Debt Has Outpaced Income Growth Since2009", January 13, 2016. Link: https://www.mhfi.com/mhfi-global-institute/articles-and-reports/Many-different-roads-to-get-there-but-total-global-debt-is-rising-relative-to-income-growth.html.

4. China sector profits from WIND, as of December 31, 2015. US sector profits from Business of Economic Analy-sis, US Department of Commerce.

5. Credit Suisse, Global Wealth Report, as of October, 2015. Link: https://publications.credit-suisse.com/tasks/render/file/?fileID=F2425415-DCA7-80B8-EAD989AF9341D47E.

6. McKinsey&Company, “2016 China Conumber Report - The Modernization of the Chinese Consumer”, as ofMarch 2016. Link: http://www.mckinsey.com/industries/retail/our-insights/here-comes-the-modern-chinese-consumer.

7. Bloomberg, as of April 01, 2015, selected by Bond Research function using criteria: 1) is defaulted 2) currencyis CNY 3)country of risk is China.

8. Chinabond.com.cn as of December 31, 2015. Link:http://www.chinabond.com.cn/Channel/19012917?BBND=2015&BBYF=12&sPageType=2.

9. National People's Congress, special report. Link: http://www.eeo.com.cn/2016/0118/282561.shtml.

10. Goldman Sachs, “Walled In: China’s Great Dilemma”, as of January 2016. Link:http://www.goldmansachs.com/what-we-do/investment-management/private-wealth-management/intellectual-capital/isg-china-insight-2016.pdf.

11. The World Bank, World Development Indicators. Link:http://data.worldbank.org/indicator/DT.TDS.DECT.EX.ZS.

12. Chinus Asset Management, “China after 2015”, as of March 09, 2016. Link:http://www.chinusinvest.com/insights/wd708w5bmfc7q0llxfg9uqbdo47l71.


30

Disclaimer:

The information presented herein is strictly confidential and is being provided to you by Deer Isle Group, LLC, orone of its affiliates, Deer Isle Capital, LLC or Deer Isle Financial, LLC, (the "Provider") for information purposesonly. Neither the Provider nor any of its affiliates, nor any of the Companies’ and/or Funds or their respectiveaffiliates' directors, officers, managers, employees or representatives (the "Provider Parties") makes anyrepresentation or warranty, express or implied, with respect to any of the material or information contained herein.None of the Provider Parties shall assume or otherwise have any responsibility or any liability whatsoever to you orany of your affiliates, or any of your or your affiliates' respective directors, officers, managers, employees orrepresentatives resulting from the use of the information and material contained herein.

As a highly confidential and proprietary transaction and/or investment (“Investment”) under no circumstances,should you contact the targets, or their affiliated advisors, representatives or owners, without written approval fromthe Provider. Information provided here is supplied in good faith based on information believed, but is notguaranteed, to be accurate or complete. The Investment described in this presentation is an exclusive andproprietary opportunity of the Provider, who is under a contractual obligation of confidentiality with respect to theinformation and material contained herein. The Provider Parties are and at all times will remain the sole owners ofthe material and/or information contained herein. Except as required by law or regulation, you may not directly orindirectly publish, disseminate or otherwise disclose, deliver or make available to any person (other than those ofyour directors, officers, managers, employees or representatives who have a need to know the information for thepurpose of evaluating an Investment between you and the Provider Parties as contemplated by this presentation),any of the material or information contained herein without the prior written consent of the Provider Parties.

This information does not constitute an offer to sell or a solicitation of an offer to buy which can only be made toqualified investors pursuant to and as described in a confidential subscription document. In considering any prior,pro forma performance, portfolio composition or track record information contained herein, prospective investorsshould bear in mind that past performance is not indicative of future results. There can be no assurance that theInvestment will achieve comparable results or that objectives will be achieved. Investments are speculative,involve a high degree of risk and performance can be volatile. An investor could lose all or a substantial amount oftheir Investment. Past performance does not guarantee future results; current performance may be lower or higherthan performance quoted.


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Deer Isle Financial, LLC

Tel: 212-488-0555

Email: [email protected]

The Fisk Building

250 West 57th Street, Suite 620

New York, NY 10107

Documents

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