The Chinese Equity Market Paradox June 2020

MarketGrader In the decade following the ‘Great Recession’ that was like the U.S., where investors were able to translate the triggered by the global financial crisis of 2007-2009, two growth in the total market capitalization into portfolio nations have been the major drivers of global econom- returns through exposure to the broad market, an inves- ic growth: China and the United States (together with a tor in Chinese stocks trying to translate growth in China’s notable contribution from India). According to the World total market capitalization into portfolio returns would Economic Outlook published by the International Mon- have been bitterly disappointed. Over the decade ending etary Fund (IMF), as recently as last year and before the 2019, an investment in China’s broadest benchmark, the global economy was brought to a halt by the coronavirus CSI All Share Index, would have resulted in a cumulative pandemic, China and the U.S. were expected to account return of 17.1%, excluding dividends and trading costs, or for almost 39% of the world’s growth in 2019-20201. In- an annualized return of 1.6%, which failed to even keep up dividually, the U.S. economy grew by more than 20% with the country’s annualized rate of inflation of 2.5%2. starting in 2010 through 2019. This translated into an an- Figure 1 illustrates this remarkable dichotomy between nual growth rate of 2.3%. Absent the pandemic, the U.S. the world’s two largest equity markets that we refer to as economy, with a total GDP of almost USD 21.5 trillion, the Chinese Equity Market Paradox. was forecast to grow by around 3% in 2020, or by around USD 650 billion, an amount that is just shy of the GDP of This paper seeks to answer two questions: First, is there a Switzerland (the smallest of the G20 economies). Over the simple and reasonable explanation for the significant di- same period, with an annual growth rate of 7.6%, China’s vergence between the growth of China’s economy and the economy more than doubled in size ending 2019 with a performance of its equity market? Second, can a better total GDP of USD 14.2 trillion. understanding of this relationship be incorporated into the design of investment strategies so that investors can With respect to their equity markets, for both the U.S and more successfully harness the economic growth of one of China, the total market capitalizations (price per share the world’s principal growth engines? times the shares outstanding aggregated across all publicly trades companies) not only grew commensurate- ly with their underlying economies but exceeded their GDP growth rates as risk assets appreciated considerably during the decade. The total market capitalization for the U.S. equity universe grew from USD 15.1 trillion starting “ An investment in China’s in 2010 to USD 36.3 trillion through 2019 for a cumulative growth of 141%, or an annualized growth of 9.2%. Indeed, total market benchmark in a passive investor owing a financial instrument tracking the last decade would have a total stock market benchmark such as the Russell 3000 Index, would have earned an annualized return of 10.9% resulted in an annualized (excluding dividends and trading costs). return of 1.6%, which failed Coincidently, the total market capitalization of China’s to keep up with the country’s domestic equity universe, which represents the second largest equity market in the world, grew by almost the rate of inflation of 2.5%. ” same amount as the U.S. The total market capitalization of all stocks trading on the Shanghai and Shenzhen exchanges grew from USD 3.6 trillion starting in 2010 to USD 8.5 trillion through 2019, for a cumulative growth of 138%, or an annualized growth of 9.1%. However, un-

1 . Source: World Economic Outlook 2019, International Monetary Fund. 2 . Inflation, consumer prices (annual %) – China. Source: World Bank

MarketGrader 2 MarketGrader Research RESEARCH & INDEXES Figure 1. The Chinese Equity Market Paradox

United States China CSI China Real GDP Total Market Capitaliza- Growth of Russell 3K Real GDP Total Market Capitaliza- Growth of All Shares Growth tion of Equity Market in Total Market Price Return Growth tion of Equity Market in Total Market Price Return USD at End of Year Capitalization (in USD) USD at End of Year Capitalization (in USD) 2009 -2.5% 15,077,285,740,000 30.1% 25.5% 9.4% 3,573,152,460,000 100.9% 106.4% 2010 2.6% 17,283,451,680,000 14.6% 14.8% 10.6% 4,027,840,300,000 12.7% -0.3% 2011 1.6% 15,640,707,040,000 -9.5% -0.9% 9.6% 3,412,108,290,000 -15.3% -24.7% 2012 2.2% 18,668,333,210,000 19.4% 12.3% 7.9% 3,697,376,040,000 8.4% 8.0% 2013 1.8% 24,034,853,520,000 28.7% 30.9% 7.8% 3,949,143,490,000 6.8% 8.4% 2014 2.5% 26,330,589,190,000 9.6% 10.5% 7.3% 6,004,947,670,000 52.1% 42.2% 2015 2.9% 25,067,539,600,000 -4.8% -1.5% 6.9% 8,188,019,320,000 36.4% 26.8% 2016 1.6% 27,352,200,720,000 9.1% 10.4% 6.7% 7,320,738,379,789 -10.6% -20.0% 2017 2.2% 32,120,702,650,000 17.4% 17.9% 6.8% 8,711,267,220,000 19.0% 8.3% 2018 2.9% 30,436,313,050,000 -5.2% -7.8% 6.6% 6,324,879,760,000 -27.4% -34.7% 2019 2.3% 36,329,851,880,000 19.4% 28.5% 6.0% 8,515,504,380,000 34.6% 30.5% Cumulative Growth 21.8% 141.0% 180.7% 108.0% 138.3% 17.1% Annualized Growth (10 Yrs.) 2.3% 9.2% 10.9% 7.6% 9.1% 1.6%

Sources: International Monetary Fund (GDP), World Federation of Exchanges (Market Capitalization), Bloomberg (Index Returns)

Privatizations with ‘Chinese Characteristics’ to the common belief that China’s economic miracle was purely a result of government design, these peasants and Following an extended period of economic stagnation and farmers should be rightly seen as the source of China’s stalled living standards globally, the late 1970s and early bottom up economic reform and their society’s original 1980s saw a wave of privatizations sweep through econ- entrepreneurs3. omies looking for a way out of their state-induced paral- ysis, a trend that would have profound repercussions in In addition to the peasants and farmers that participated China a decade later. As countries such as Chile and the in the grassroot movement, credit is also due to the coun- United Kingdom began to reconsider the economic and try’s leadership under Deng Xiaoping, which allowed the social benefits of state ownership of some the country’s green shoots of reform to take root and turn into a move- largest companies, governments around the world took ment that improved the lives of millions of Chinese in note, especially those in Eastern Europe and the Soviet meaningful ways. The Deng-led Chinese Communist Par- Union, where the economy was slowly crumbling under ty (CCP) was wise to embrace this challenge by the coun- the heavy hand of the state. In China this trend coincided try’s rural population to the “status quo” and eventually with a grassroots movement that began in the countryside let it expand to other areas of the economy in the guise in the late 1970s, where millions of farmers and peasants of policy platforms such as ‘reform and opening’ and the sought to break free from the yoke of farm collectives that ‘four modernizations,’ that were put in motion by the had decimated the country’s agricultural output and their state in the late 1970s and early 1980s. As these policies livelihoods for decades. Their simple goal was to allow in- began to bear fruit and the country embarked on a path of dividual families to fill state production quotas more effi- industrialization, the Party’s leaders understood that the ciently, enabling them to retain the surplus for their own country would need two key elements that were essential consumption or to sell it in the fledgling street markets to fuel this ongoing transformation: direct investment sprouting in cities throughout the country. This trend to- combined with managerial expertise and know-how. wards commercialization not only helped foster the be- Having a scarcity of both domestically, they concluded, ginning of urbanization in China, but by creating market that the path forward was through the privatization, or incentives, increased the country’s agricultural output sale, of state assets. Privatizations could rapidly attract significantly and, more importantly, liberated the entre- foreign direct investment into a country with a massive preneurial spirit that had been repressed inside millions 3 . Paul R. Gregory and Kate Zhou, “How China Won and Russia Lost,” of Chinese during decades of communist rule. Contrary Hoover Institution Publications (December 1, 2009)

MarketGrader 3 MarketGrader Research RESEARCH & INDEXES economic potential and an untapped consumer market, Selling State Assets Without Giving up Control while simultaneously importing production efficiencies

(economies60% Primaryof scale) Industry and management know-how that The disastrous ‘privatization’ of state assets in Russia could be implementedSecondary Industry by the country’s large but sclerot- and the former members of the Soviet Union in the early Tertiary Industry ic 50%state-owned enterprises (SOEs). China’s urgent need 1990s informed a significant part of China’s privatization for foreign direct investment to modernize its economy drive, with the Chinese Communist Party (CCP) deter- 40% in the 1980s thus provided the primary impetus for the mined not to give up ownership or to lose control over country’s own privatization program and the subsequent state assets despite their need to attract foreign direct 30% creation of the country’s stock exchanges. As the flood- investment into the country. The “shock” privatization gates20% opened, foreign capital rushed into the country in schemes rolled out in Russia and in former Soviet repub- a way not seen before or since among emerging markets lics consisted mostly, in simplistic terms, of the distri- (Figure10% 2), gradually turning China into a manufacturing bution of state assets among the population through a juggernaut and, eventually, into one of the world’s largest voucher program that allowed citizens to bid at auctions 0% consumer'78 '80 markets'83 '86 (Figure'89 '92 3).'95 '98 '01 '04 '07 '10 '13' '16 for shares in state enterprises at deeply discounted prices. The state, however, never established the legal and regu-

Figure 2. Foreign Direct Investment, Brazil, China, India & latory frameworks necessary for the operation of a mar- Russia 1982-2012 ket economy based on the principle of private property

$250B $241.21B ownership and protection. Opportunistic investors, with access to relatively small amounts of capital compared to $225B Brazil $200B China the scale of the assets on offer, were thus able to acquire India massive stakes in state assets by scooping up vouchers $175B Russian Federation from cash-strapped citizens who could no longer count $150B on the state for sustenance. China, in contrast, made $125B clear at the outset of its privatization campaign that the $100B program’s key objective would be to preserve the state’s $75B $53.07B ownership of the assets it would contribute to its newly $50B “corporatized” SOEs. It declared, therefore, that although $25B $11.16B $430M shares in its SOEs would be sold to private investors, the 0 1982 1992 2002 2012 state would nevertheless maintain absolute majority of Foreign direct investment, net inflows (BoP, current US$). Source: World Bank the enterprises4. China, with its much larger population, Figure 3. Composition of China’s GDP by was determined to avoid, at all costs, the social and po- Three Strata of Industry 1978-2016 litical unrest Russia experienced after the Soviet Union’s disintegration. It did so, in part, by making SOEs the pri- 60% Primary Industry Secondary Industry mary drivers of the state’s social policies.

50% Tertiary Industry In order to achieve its dual goal of raising capital and 40% maintaining control, the state authorized the creation of two types of shares for every entity it would privatize: 30% “A-shares,” to be floated publicly and be freely tradable on the newly created stock markets and non-tradable 20% shares, broadly defined as those with any affiliation to

10% the state (and which eventually came to be known as ‘LP’ shares). These included shares distributed to local gov-

0% ernments, which owned significant portions of the assets '78 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13' '16

Primary Industry refers, essentially, to agriculture; Secondary Industry refers to mining, manufacturing, energy production and construction; and Tertiary Industry 4 . Privatizing China: Inside China’s Stock Markets. Carl E. Walter & refers to consumption and services. Source: National Bureau of Statistics of China Fraser J.T. Howie.

$250B $241.21B MarketGrader 4 MarketGrader Research RESEARCH & INDEXES

$225B Brazil $200B China India $175B Russian Federation

$150B

$125B

$100B

$75B $53.07B $50B

$25B $11.16B $430M 0 1982 1992 2002 2012 contributed into the newly corporatized SOEs and could Figure 4. Negotiable Market Cap as % of Total Market Cap, China 1999-2019 not be sold or floated without the explicit consent of the 100% central government. Thus, at the outset of the market experiment in China, a bifurcated market developed which 100% Shenzhen would have lasting consequences on the development of 80% Shanghai its equity markets. This gradual privatization approach Shenzhen 80% China(SZ+SH) made China an outlier among countries on the privatiza- 60% Shanghai tion path, as it allowed its state-owned firms to continue China(SZ+SH) 60% to exist alongside an emerging private economy that rap- 40% idly overtook the state-directed portion of the economy in size. However, while this approach allowed the state 40% 20% to maintain control over its SOEs, most of the problems that plague the country’s stock market to this day can be 20% 0% traced back to this system. '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

Sources: Shanghai Stock Exchange & Shenzhen Stock Exchange 0% The State-Owned Enterprise Dilemma '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 Figure4000 5. Number of Listed Companies in China Between 1999 and 2019 The dual-market system described above created two 3500 4000 Shenzhen singular problems that would affect the performance of 3000 3500 Shanghai China’s stock market for years to come and can be traced Shenzhen 2500 China(SZ+SH) to a single source, namely, the SOEs. The first problem 3000 Shanghai came from the overhang the state created for early stock 2000 2500 China(SZ+SH) market investors who rightly feared that, as the state 1500 sought additional capital to support the country’s ongo- 2000 1000 ing reforms, its gradual floating of ‘non-tradable’ shares 1500 would massively dilute the owners of the freely tradable A 500 1000 shares. In the stock market’s early days, and as recently 0 as the early 2000s, ‘A share’ investors owned only about 500 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

30% of the notional market capitalization of the average 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 company listed publicly in China, underscoring the legit- 350% Sources: Shanghai Stock Exchange & Shenzhen Stock Exchange. Count includes only imacy of their concerns. This was a particular problem for ‘A Shares’ and notShenzhen ‘B Shares,’ Stock which Exchange were Composite companies listed in foreign currencies. 300% Shanghai Stock Exchange Composite investors buying shares on the Shanghai Stock Exchange, 350% The overhangShenzhen problem Stock Exchangenot only Composite prevented a broader par- where most of the earliest SOEs listed. In contrast, the 250% ticipation300% byShanghai private Stock investors Exchange Composite in China’s equity markets Shenzhen Stock Exchange began to attract private enter- but200% also resulted in abysmal stock market performance at 250% prises earlier than its Shanghai sibling, especially from the turn of the century, unsettling investors who became companies based in and around the prosperous Guang- 150% unwilling200% to allocate additional capital to listed compa- dong province, where much of China’s manufacturing 100% nies150% given the uncertainty of how much their stakes in the and technology base lay down roots in the early days of SOEs50% would eventually be worth. Ultimately the state had the country’s modernization drive. Figure 4 presents the 100% to pay off A share investors by issuing additional shares in gradual growth of both markets’ negotiable market value 0% the50% SOEs whose shares it floated, partially compensating relative to total market value for both exchanges and for them-50% for the massive dilution of their economic interests China in the aggregate while Figure 5 displays the total 12/31/990% 12/31/01 12/31/03 12/30/05 12/28/07 in the listed entities. It wasn’t until such a mechanism number of (A Shares) listed companies between 1999 and -50% was12/31/99 implemented,12/31/01 starting in12/31/03 2005, that the12/30/05 market re12/28/07- 2019. ceived the ‘all clear’ signal to take off, as illustrated in Figure 6. In other words, as the state’s footprint in the stock$250 market shrank, share prices rose and private inves- CSI SOE Composite Index CSI All Share Index $250 CSI 300 Index CSI SOE Composite Index MarketGrader 5 MarketGrader Research $200 RESEARCH & INDEXES CSI All Share Index CSI 300 Index $200

$150

$100

$100 $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20

$50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20

50%

50% 40%

40% 30%

30% 20%

20% 10%

10% 0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China

Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 0% MGNegative China Growth Leaders CSI 300 CSI SOE Composite MSCI China

Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10%

Negative 60% 58%

50% 46% 44% 60% 58% 40% 50% 46% 44% 30% 40% 20% 16% 30% 10% 20% 16% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 0% Negative CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 60% Negative 52% 50% 60% 40% 52% 50% 30% 26% 26% 40% 20% 30% 26% 26% 10% 7% 20% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy7% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 800 Greater than 20% Between 10% and 20% Between 0 and 10% Negative 700 600800 500700 400600 300500 200400 100300 2000 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 100 0 80% 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 70% 60%80% 50%70% 40%60%

30%50% 25% 20%40% 11% 9% 10%30% 25% 1% 20%0% CSI MG China CSI 300 11%CSI SOE Composite MSCI China9% 10% New Economy Greater than 200%1% Between 100% and 200% Between 0 and 100% Negative 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative 50% 42% 40% 38% 50% 42% 31% 30% 40% 38%

20% 31% 30%

10% 20% 3% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy3% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 80% New Economy 73% 70% Greater than 200% Between 100% and 200% Between 0 and 100% Negative

60%80% 56% 73% 50%70% 49%

40%60% 56% 30%50% 49% 20%40% 14% 10%30% 20%0% CSI MG China14% CSI 300 CSI SOE Composite MSCI China 10% New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 0% BetweenCSI MG 10% Chinaand 20% LessCSI than 30010% CSI SOE Composite MSCI China New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 70% Between 10% and 20% Less than 10% 63% 60% 70% 50% 63% 42% 60% 40% 40% 50% 30% 42% 40% 40% 20% 13% 30% 10% 20% 0% 13% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 0% Negative CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 50% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

40% 50%

30% 40%

20% 30% 15%

10% 20% 7% 15% 5% 1% 0% 10% CSI MG China CSI 300 CSI SOE Composite 7%MSCI China New Economy 5% Greater than 50% Between 40% and 50% Between1% 30% and 40% Between 20% and 30% 0% Between 10% and 20% Less than 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 90% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 80% 80% Between 10% and 20% Less than 10%

70%90% 80% 60%80% 50%70% 45% 45% 46% 40%60% 30% 50% 45% 45% 46% 20%40% 10%30% 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 10% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 0% Less than 30% CSI MG China CSI 300 CSI SOE Composite MSCI China 40% New Economy Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 35% Less than 30% 30% 30%40% 29% 35% 25% 22% 30% 20%30% 29%

15%25% 22% 10%20% 15%5% 10%0% CSI 300 CSI SOE Composite MSCI China 5% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 0% Less than 4% CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4%

50 Average (all companies) Weighted Average 40.6 40 50 35.6 35.2 33.0Average (all companies) 33.4 Weighted Average 30 40.6 27.2 40 26.6 25.3 35.6 35.2 33.0 33.4 20 30 27.2 26.6 25.3 10 20

0 10 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 45%

40% 50% 45% 31% 30% 40% 23% 20% 18% 31% 30% 23% 10% 20% 18%

0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

90% 82% 80%

70%90% 63% 82% 62% 60% 80% 51% 50%70% 62% 63% 40%60% 51% 30%50% 20%40% 10%30% 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 50% 37% 43% 30% 30% 40% 38% 23% 37% 20% 17% 30% 30% 14% 15% 13% 13% 23% 12% 12% 10% 20% 17% 14% 15% 13% 13% 0% 12% 12% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 50% 36% 35% 45% 30% 40% 36% 35% 20% 30% 16%

10% 20% 16% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 110% 102% 100% 90% 82% 110%80% 102% 100%70% 60%90% 82% 50%80% 40%70% 30%60% 20%50% 15% 10%40% 6% 30%0% 20% MG China CSI15% 300 CSI SOE Composite MSCI China Growth Leaders 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 60%

40%

20%

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

3500 Shenzhen 3000 Shanghai

2500 China(SZ+SH)

2000

1500 tors1000 gradually began to evaluate shares based more on the itself, not only as some of the country’s biggest employ- intrinsic value of the issuers and less on the role played by ers, but also as providers of social services including ed- 500 the state in the issuance (more on this later). ucation, health insurance and social security to their em- 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 ployees, retirees and their families. Extracting SOEs from Figure 6. Shanghai Composite and Shenzhen Composite Per- formance, Dec. 1999 - Dec. 2007 such a role early in China’s privatization process would 350% not only have affected tens of millions of Chinese fami- Shenzhen Stock Exchange Composite lies but, the state feared, could have also undermined the 300% Shanghai Stock Exchange Composite entire market experiment, creating political instability 250% for the CCP. Inside each of these entities, however, was

200% a productive enterprise with a mandate, after privatization, to maximize profits and shareholder returns. Hav- 150% ing to satisfy these contradictory objectives of playing a 100% social role for employees on behalf of the Chinese state

50% and maximizing profits on behalf of shareholders imped- ed the development of SOEs into efficient, professionally 0% managed enterprises that would allow China to compete -50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 on a global stage. At this time China was preparing to gradually enter the World Trade Organization (WTO) be- Sources: Shanghai Stock Exchange & Shenzhen Stock Exchange. tween 2001 and 2006. As a result of this ‘compensation’ scheme, the specter of$250 massive dilutions in SOEs receded but not entirely. In It is ironic that by holding on to its majority ownership fact, today thereCSI SOE are Composite still Index over 1,100 SOEs listed in China’s in SOEs and by limiting their ability to act purely on be- CSI All Share Index exchanges with an aggregate market capitalization of USD half of their newly created private owners, the state held CSI 300 Index 4.7$200 trillion. In the aggregate, only 36% of their shares are them back from becoming the blue-chip Chinese compa- publicly traded, with the remaining 64% owned by the nies it sought them to become through the privatization central or local governments or by entities controlled by model. In addition, within many of the SOEs, this dual $150 the state. Furthermore, these companies account for al- mission of serving the state in spite of its private share- most 58% of China’s total domestic stock market5. This holders fostered a culture of stagnation, inefficiency and means that for many investors who gain exposure to bureaucracy, resulting in dismal stock returns, which still $100 Chinese equities through investment strategies tracking plagues their shareholders to this day. In the early days broad benchmarks, more than 50% of their allocation is of China’s domestic equity markets, when listing approv- to $50SOEs, thereby making the Chinese state their most als and investment decisions were largely political, these 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 significant investment partner. To illustrate this more companies dominated China’s domestic equity markets. clearly, in the next section we will examine a few popular Therefore, many of China’s private companies, especial- benchmarks that are used by investors to gain access to ly the ones which required increasingly large amounts of 50% the Chinese equity markets. capital to propel their rapid growth, chose foreign stock markets to list their shares, especially Hong Kong and, 40% Another problem plaguing China’s market at the start of later, the United States. For international investors this the century had to do with the goals the newly corpora- created yet another class of Chinese shares to track, of- tized30% SOEs had to pursue in serving two different masters ten incentivizing them to bypass the complex, political, with different objectives, namely, the state and private and largely inaccessible A share market altogether. Thus, shareholders.20% Many times these objectives could be con- many of today’s allocations by international investors to tradictory. For the state, SOEs played a significant role Chinese equities continue to be limited to listings in Hong that10% went beyond helping to monetize state assets; they Kong and the U.S., which miss the opportunities available acted—and many still do—as an extension of the state in China’s domestic stock market.

0% 5 . Source:MG China China Growth Securities Leaders IndexCSI 300 Co. CSI SOE Composite MSCI China

Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10%

Negative MarketGrader 6 MarketGrader Research RESEARCH & INDEXES

60% 58%

50% 46% 44% 40%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

60% 52% 50%

40%

30% 26% 26%

20%

10% 7%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 20% Between 10% and 20% Between 0 and 10% Negative

800 700 600 500 400 300 200 100 0 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100

80% 70% 60% 50% 40%

30% 25% 20% 11% 9% 10% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

50% 42% 40% 38%

31% 30%

20%

10% 3% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

80% 73% 70%

60% 56% 50% 49% 40% 30% 20% 14% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10%

70% 63% 60%

50% 42% 40% 40%

30%

20% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

50%

40%

30%

20% 15%

10% 7% 5% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10%

90% 80% 80% 70% 60% 50% 45% 45% 46% 40% 30% 20% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% Less than 30% 40% 35% 30% 30% 29%

25% 22% 20% 15% 10% 5% 0% CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4%

50 Average (all companies) Weighted Average 40.6 40 35.6 35.2 33.0 33.4 30 27.2 26.6 25.3

0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 45%

40% 31% 30% 23% 20% 18%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

90% 82% 80% 70% 62% 63% 60% 51% 50% 40% 30% 20% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 37%

30% 30% 23% 20% 17% 14% 15% 12% 12% 13% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 60%

40%

20%

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

3500 Shenzhen 3000 Shanghai

2500 China(SZ+SH)

2000

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0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

350% Shenzhen Stock Exchange Composite 300% Shanghai Stock Exchange Composite

250%

200%

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100%

50%

-50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07

The Role of State-Owned Enterprises in China’s Figure 7. $100 Investment in China’s Benchmarks a Decade Ago (March 2010 - March 2020) Stock Market Today $250 CSI SOE Composite Index In recent years, the number of SOEs as a proportion of all CSI All Share Index listings, has declined considerably in China’s equity mar- CSI 300 Index $200 ket universe. However, because of their size, SOEs still account for an estimated 58% of the total market capital-

6 ization of China’s domestic equity market . In addition, $150 despite the ongoing reform and privatization efforts described above, only 36% of the notional value of all of Chi- na’s SOEs is freely tradable, with the rest closely held by $100 the central government, local governments or state-af- filiated parties. Furthermore, some of the largest com- $50 panies in China (and in some cases some of the largest 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 companies within their sectors globally) are still owned Source: China Securities Index Company (CSI). by the state, which means that any investor gaining exposure to Chinese equities through a broad market cap The50% Relationship Between Capital Misallocation weighted investment strategy, is likely to have a signif- and Poor Investment Returns icant exposure in their portfolio to SOEs. Consequently, 40% broad Chinese benchmarks with large exposures to the The source of the problems with SOEs—and the perfor- country’s SOEs have also performed dismally and offered mance of their stocks—can be traced to the role these 30% investors almost no long-term capital returns. For exam- companies are expected to play in China, where private ple, the CSI 300 Index, which is comprised of the largest shareholders usually take a back seat to the state’s de- 20% and most liquid stocks in China and is the A-Share mar- mands and capital allocation directives that have little to ket’s most widely followed benchmark, has delivered no do with maximizing shareholder value. State mandates appreciation in the last 10 years. An investment of $100 for10% its SOEs have, over many years, saddled these com- in an investment strategy tracking the CSI 300 a decade panies with excess capacity, bloated payrolls and cost ago would have earned a meager $6.20 (excluding divi- structures,0% massive debt loads and very poor returns on MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China dends and trading costs) during a 10-year period that the invested capital. This last characteristic is particularly Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% market capitalization of the country’s equity market more importantNegative for investors in their public shares, as capital than doubled in size. The All-Shares market index only allocation decisions that are made at the behest of the fared marginally better. An investment of $100 in an in- state often times run counter to the best interests of pri- 60% 58% vestment strategy tracking all of China’s investable uni- vate shareholders. SOEs are, in fact, the state’s primary 50% verse would have earned $8.80 (excluding dividends and means of executing its fiscal46% policy as it directs 44%specific 40% trading costs). But as poor as both of these investments capital allocations to preferred political objectives with were in the last decade, they outperformed China’s SOEs, relatively30% little regard for the return on invested capital. where a $100 investment would have lost $1.42. These re- In20% many cases16% these directives go hand in hand with Chi- sults are illustrated in Figure 7. na’s10% foreign policy objectives, as exemplified by its Belt and Road Initiative that encompasses infrastructure proj- 0% CSI MG China CSI 300 CSI SOE Composite MSCI China ects inNew Europe, Economy Africa, the Middle East and throughout all Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% of Asia.Negative While this is a government initiative seeking to bring an increasing number of countries within China’s 60% economic and military orbit, most of its52% execution is left to50% SOEs acting on the government’s behalf. As an exam- 6 . Based on the aggregate market capitalization of the CSI State-Owned 40% Enterprises Composite Index relative to the aggregate market capitaliza- ple, when choosing to engage in infrastructure spending tion of the CSI All Share Index, the broadest measure of China’s domestic both30% abroad and domestically—a favorite fiscal policy stock market, as of April 15, 2020. Source: China Securities Index Co. 26% 26% (CSI). 20%

10% 7% MarketGrader 7 MarketGrader Research RESEARCH & INDEXES 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 20% Between 10% and 20% Between 0 and 10% Negative

800 700 600 500 400 300 200 100 0 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100

80% 70% 60% 50% 40%

30% 25% 20% 11% 9% 10% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

50% 42% 40% 38%

31% 30%

20%

10% 3% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

80% 73% 70%

70% 63% 60%

50% 42% 40% 40%

30%

20% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

50%

40%

30%

20% 15%

10% 7% 5% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10%

25% 22% 20% 15% 10% 5% 0% CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4%

50 Average (all companies) Weighted Average 40.6 40 35.6 35.2 33.0 33.4 30 27.2 26.6 25.3

0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 45%

40% 31% 30% 23% 20% 18%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

90% 82% 80% 70% 62% 63% 60% 51% 50% 40% 30% 20% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 37%

30% 30% 23% 20% 17% 14% 15% 12% 12% 13% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 60%

40%

20%

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

3500 Shenzhen 3000 Shanghai

2500 China(SZ+SH)

2000

1500

1000

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0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

350% Shenzhen Stock Exchange Composite 100% 300% Shanghai Stock Exchange Composite

250% Shenzhen 80% Shanghai 200%

China(SZ+SH) 60% 150%

100% 40% 50%

20% 0%

-50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

$250 3500 CSI SOE Composite Index Shenzhen CSI All Share Index 3000 Shanghai CSI 300 Index $200 2500 China(SZ+SH)

2000

1500 $150

1000

500 $100

0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 350% Shenzhen Stock Exchange Composite 300% Shanghai Stock Exchange Composite

50% 250%

200% 40% 150%

100% 30%

50%

20% 0%

-50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 10%

0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China

Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10%

$250 Negative CSI SOE Composite Index CSI All Share Index CSI 300 Index 58% $200 60%

50% 46% 44% 40% $150 30%

20% 16%

$100 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy $50 tool of the Chinese government—the state might instruct FigureGreater 9. Economic than 30% Between Value 20% andAdded 30% forBetween Select 10% and China20% BetweenEquity 0 and 10% 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 Negative Indexes specific state-owned banks to direct capital to particular projects, usually at below market rates; materials used 60% 52% in its construction are often procured from state-owned 50% 50% cement and steel makers, for example, and construction 40% is done by state-owned builders and engineering firms. 30% 26% 40% 26% Nowhere in this cycle of state-directed capital allocation 20% are private shareholders more than passive co-investors 10% 7% with30% the state. It is no surprise then that the quality of 0% CSI MG China CSI 300 CSI SOE Composite MSCI China these companies’ financials are suboptimal and, in many New Economy cases,20% divorced from the most dynamic sources of growth Greater than 20% Between 10% and 20% Between 0 and 10% Negative underpinning China’s development. The extent of this Data is as of April, 2020 and excludes all indexes’ constituents in the Financials sector. Sources: FactSet, MarketGrader, China Securities Index Co. 800 misallocation10% of capital problem for SOEs is presented in The700 problem isn’t confined to the SOE benchmark, con- Figure 8 which shows that almost 60% of all of the coun- sidering600 that SOEs still comprise a very large portion of try’s0% publicly traded SOEs have returns on invested capi- 500 MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China China’s overall equity market, which makes them ubiq- tal below 10%. 400 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% uitous among all of the country’s widely followed market 300 Negative Figure 8. Returns on Invested Capital for Select China Equity capitalization-weighted200 indexes. Given that SOEs, with Indexes an100 aggregate market capitalization of USD 4.7 trillion, ac- 0 60% 58% count0 to for 10 1058% to 20 of20 to the 30 30 entire to 40 40 to A 50 share50 to 60 60market, to 70 70 to 80 they80 to 90 represent90 to 100

50% massive portions of the country’s most widely followed 46% 44% benchmarks,80% which investors use as proxies for Chinese 40% 70% stock market performance. For example, in the CSI 300 30% 60% Index SOEs comprise 69% of the benchmark’s total mar- 50% 20% 16% ket40% capitalization. Furthermore, the problem isn’t limit- 10% ed30% to domestic benchmarks only. SOEs25% represent, for ex- 0% ample,20% 50% of the total market capitalization of the MSCI CSI MG China CSI 300 CSI SOE Composite MSCI China 11% 9% New Economy 10% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% China Index.1% This benchmark, along with similar broad Negative 0% CSI MG China CSI 300 CSI SOE Composite MSCI China ChineseNew Economymarket capitalization weighted indexes from Data is as of April, 2020 and excludes all indexes’ constituents in the Financials sec- Greater than 200% Between 100% and 200% Between 0 and 100% Negative 60%tor. Sources: FactSet, MarketGrader, China Securities Index Co.: global index providers, is widely followed by international 52% investors, who might be unaware of the extent to which 50% they’re50% partnering with the Chinese government when When40% taking the cost of capital into account, including buying into Chinese equities through 42%investment strate- the cost of equity and debt, the problem is even more dire, 40% 38% 30% 26% 26% gies tracking those benchmarks. In fact, when measuring with 46% of all publicly traded SOEs failing to generate a 31% 20% the30% total market capitalization of all SOEs in China, inves- high enough return to cover their costs of capital, as mea- 10% 7% tors should consider that only 36% of these companies’ sured by the ‘economic value added’ or EVA, of their total 20% 0% total market cap is freely tradable, with the remaining investedCSI MGcapital. China Astonishingly,CSI 300 CSI SOE90% Composite of all SOEsMSCI Chinahave an 10% New Economy 7 64% in the hands3% of various state players . This problem economicGreater thanvalue 20% addedBetween 10% below and 20% 10%,Between and 0 and 10% thisNegative is after exclud- 0% isn’t simplyCSI MG China one of indexCSI 300 weightingCSI SOE Composite but alsoMSCI one China of selec- ing SOEs in the Financial sector, which require different New Economy 800 tion, since, by definition, market cap weighted bench- return metrics. This is presented in Figure 9. Greater than 200% Between 100% and 200% Between 0 and 100% Negative 700 marks80% must select the largest companies to track, regard- 600 73% less70% of quality. In China this often leads to the selection of 500 SOEs,60% especially for benchmarks56% that exclude the issues 400 49% of50% private Chinese companies listed overseas, especially 300 40% 200 in Hong Kong and the United States. 30% 100 20% 14% 0 7 . Sources: China Securities Index Co. for CSI SOE Composite and CSI 300; 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 FactSet10% for MSCI China. 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 80% New Economy MarketGrader 8 MarketGrader Research Between 40% and 50% Between 30% and 40% Between 20% RESEARCHand 30% & INDEXES 70% Greater than 50% Between 10% and 20% Less than 10% 60% 50% 70% 40% 63% 60% 30% 25% 50% 20% 42% 40% 11% 9% 10% 40% 1% 0% 30% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 20% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China 50% New Economy 42% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative 40% 38%

31% 50% 30%

40% 20%

30% 10% 3% 20% 0% 15% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 10% 7% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 5% 1% 80% 0% 73% CSI MG China CSI 300 CSI SOE Composite MSCI China 70% New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 60% 56% Between 10% and 20% Less than 10% 49% 50% 90% 80% 40% 80% 30% 70% 20% 60% 14% 10% 50% 45% 45% 46% 40% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 20% Between 10% and 20% Less than 10% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 70% 63% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 60% Less than 30% 40% 50% 42% 40% 35% 40% 30% 30% 29% 30% 25% 22% 20% 20% 13% 10% 15%

0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 5% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative 0% CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 50% Less than 4%

40%

30%

20% 15%

10% 7% 5% 1% 50 0% Average (all companies) CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Weighted Average 40.6 40 Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 35.6 35.2 Between 10% and 20% Less than 10% 33.0 33.4 30 27.2 90% 26.6 25.3 80% 80% 20 70%

60% 10 50% 45% 45% 46% 40% 0 CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy 20% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% Less than 30%

40% 50% 45% 35% 30% 30% 29% 40% 31% 25% 22% 30% 20% 23% 15% 20% 18% 10% 10% 5%

0% 0% CSI 300 CSI SOE Composite MSCI China CSI MG China CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% New Economy Less than 4%

90% 82% 80%

70% 63% 50 62% Average (all companies) 60% Weighted Average 51% 40.6 50% 40 35.6 35.2 40% 33.0 33.4 30% 30 26.6 27.2 25.3 20% 20 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 10 New Economy

0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 37%

50% 30% 45% 30% 23% 40% 20% 17% 31% 14% 15% 13% 13% 30% 12% 12% 10% 23% 20% 18% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 10% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 45% 90% 82% 40% 80% 36% 35% 70% 62% 63% 30% 60% 51% 50% 20% 16% 40% 30% 10% 20% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China 0% New Economy CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 50% 43% 40% 40% 38% 37% 30% 15% 30% 20% 30% 10% 6% 23% 0% MG China CSI 300 CSI SOE Composite MSCI China 20% 17% Growth Leaders 14% 15% 12% 12% 13% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 60%

40%

20%

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

3500 Shenzhen 3000 Shanghai

2500 China(SZ+SH)

2000

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0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

350% Shenzhen Stock Exchange Composite 300% Shanghai Stock Exchange Composite

250%

200%

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100%

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-50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07

$250 CSI SOE Composite Index CSI All Share Index CSI 300 Index $200

$150

$100

$50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20

MarketGrader’s Approach: Focused on Company four50% categories: Growth, Value (GARP part of the analysis), Selection Profitability and Cash Flow (Quality part of the analysis).

Each40% one of the 24 indicators is assigned an individual Investors interested in China’s stock market can avoid grade and all 24 grades are aggregated into a final Market- the pitfalls of overexposure to SOEs by following a differ- Grader Score (MG Score TM) between zero and 100. We then 30% ent set of benchmarks that are more attuned to the true rate as ‘BUY’ all of those with an MG ScoreTM greater than drivers of Chinese economic growth. Many would argue 60 and as ‘SELL’ all of those with an MG ScoreTM below 50. 20% that the simplest way to achieve this would be to exclude The remaining companies are rated ‘HOLD’. SOEs from the benchmark or from an investment portfo- 10% lio, but this is a blunt solution to a problem that requires Some of our 24 indicators vary based on industry, sector or a finer approach; especially because there are plenty of size in order to account for differences across companies 0% high quality SOEs in dynamic areas of China’s economy (forMG example, China Growth theLeaders balanceCSI 300 sheetCSI SOEof a Composite large bankMSCI looks China very which could prove beneficial for investors. MarketGrad- differentGreater than from 30% thatBetween of20% anda software 30% Between company), 10% and 20% Between yet all 0 and indica10% - er’s approach to the Chinese equity market is to focus on torsNegative always adhere to our GARP plus Quality approach. In stock selection based on company quality. More specif- the end, the system’s goal is to identify sustainable growth ically, MarketGrader’s approach selects companies that compounders with the following characteristics: 60% 58% are growing at a faster rate than the overall economy 50%• Consistent top to bottom46% line growth—not and that possess attributes associated with sound capi- 44% 40% just explosive short-term growth—with sus- tal stewardship and robust fundamentals, but whose fu- tainable margins and high cash flow genera- 30% ture value is not yet reflected in their share price. Essen- tion. tially, the stock selection can be summarized as a GARP 20% 16% • A sound capital structure that doesn’t impair (growth-at-a-reasonable-price) approach with a goal of 10% operating growth, combined with high returns identifying what we refer to as ‘growth compounders,’ or 0% onCSI MGinvested China capitalCSI 300 and CSIlow SOE capital Composite intensity.MSCI China companies that we believe are the most consistent cre- New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% ators of long-term shareholder value. Consistent with • ReasonableNegative valuations relative to sustainable these beliefs, in 2015 MarketGrader launched a series of growth rates, and not based just on absolute, 60% Chinese indexes whose goal is to benchmark the perfor- out of context, valuation multiples.52% 50% mance of growth compounders within Chinese equities, Since40% MarketGrader began covering the Chinese equity and hence the capital appreciation opportunities in one market, our BUYs have averaged 16% of the universe and of the world’s fastest growing economies. Among these is 30% 26% 26% our SELLs have averaged 67%. Figure 10 shows Market- the CSI MarketGrader China New Economy Index, which, 20% Grader’s breakdown of all companies under coverage in in addition to its focus on company selection, limits its 10% 7% our Chinese investable universe by MarketGrader Score exposure to four economic sectors: consumer discretion- 0% and byCSI rating. MG China CSI 300 CSI SOE Composite MSCI China ary, consumer staples, health care, and technology. We New Economy Greater than 20% Between 10% and 20% Between 0 and 10% Negative call these China’s ‘new economy’ sectors, as we expect Figure 10. Decile Grade Breakdown for China, April 2020 companies from these sectors to be the primary drivers 800 of the country’s future growth. For more about our views 700 on China’s transformation from a manufacturing and ex- 600 port based economy to a consumer, services and technol- 500 400 ogy driven economy please refer to our 2018 paper titled 300 China’s Next Chapter. ‘ ’ 200 100 0 The process of identifying China’s growth compounders 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 begins with the analysis of every publicly traded company BUYs 492 Companies in the equity universe, which for China totals more than 80%HOLDs 533 Companies SELLs 2,717 Companies 2,700 companies. In our analysis we apply 24 fundamen- 70% 60%Source: MarketGrader. tal metrics to every company, dividing all indicators into 50% 40% MarketGrader 9 MarketGrader Research RESEARCH & INDEXES 30% 25% 20% 11% 9% 10% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

50% 42% 40% 38%

31% 30%

20%

10% 3% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative

80% 73% 70%

70% 63% 60%

50% 42% 40% 40%

30%

20% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

50%

40%

30%

20% 15%

10% 7% 5% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10%

25% 22% 20% 15% 10% 5% 0% CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4%

50 Average (all companies) Weighted Average 40.6 40 35.6 35.2 33.0 33.4 30 27.2 26.6 25.3

0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 45%

40% 31% 30% 23% 20% 18%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

90% 82% 80% 70% 62% 63% 60% 51% 50% 40% 30% 20% 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 37%

30% 30% 23% 20% 17% 14% 15% 12% 12% 13% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 100%60%

Shenzhen 40%80% Shanghai

China(SZ+SH) 20%60%

40%0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

20% 4000

35000% '99 '01 '03Shenzhen'05 '07 '09 '11 '13 '15 '17 '19 3000 Shanghai

China(SZ+SH) 25004000

20003500 Shenzhen 15003000 Shanghai

10002500 China(SZ+SH) 100%

2000500 Shenzhen 80% 15000 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 Shanghai 1000 China(SZ+SH) 60% 350% 500 Shenzhen Stock Exchange Composite 300% Shanghai Stock Exchange Composite 40% 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 250%

20% 200%350% Shenzhen Stock Exchange Composite 150%300% Shanghai Stock Exchange Composite 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 100%250%

200%50% 4000 150%0% 3500 Shenzhen 100%-50% 3000 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 Shanghai 50% 2500 China(SZ+SH)

0% 2000

-50% 1500 $25012/31/99 12/31/01 12/31/03 12/30/05 12/28/07 CSI SOE Composite Index 1000 CSI All Share Index CSI 300 Index 500 $200

0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 $250 CSI SOE Composite Index $150 CSI All Share Index 350% CSI 300 Index Shenzhen Stock Exchange Composite $200 300% Shanghai Stock Exchange Composite $100 250% $150 200% $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 150% $100 100%

50% 50% $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 0%

40% -50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07

50% 30%

40% 20% $250 CSI SOE Composite Index CSI All Share Index 30% 10% CSI 300 Index $200 20% 0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China

$150 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 10% Negative

0% $100 60%MG China Growth Leaders CSI 300 CSI SOE Composite58% MSCI China

Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 50% 46% Negative 44% $50 40% 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 30% 60% 58% 20% 16% 50% 46% 10% 44% 50% 40% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy 40% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 20% Negative 16%

10% 60% 30% 0% 52% 50% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 20% 40% Negative

30% 26% 26% 60% 10% 20% 52% 50% 10% 7% 40% 0% 0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy 26% 26% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 20% Negative

10%800 7%

7000% 60% 58% CSI MG China CSI 300 CSI SOE Composite MSCI China 600 New Economy trailing 12-month operating margin in excess of 20%, Quality Growth Greater than 20% Between 10% and 20% Between 0 and 10% Negative 50% 46% 500 44% compared to only 22% for the CSI 300, 12% for the CSI SOE 400 40% 800 The methodology outlined above allows MarketGrader to Composite,300 and 23% for MSCI China. Perhaps, the most 30% 700 select companies with much better fundamental profiles telling200 amongst all the metrics, especially in the context 600 than20% those benchmarks16% which select their constituents of100 the oversized role SOEs play in China’s equity market 500 0 on10% the basis of size. Unsurprisingly, when we compare as highlighted0 to 10 10 to 20 throughout20 to 30 30 to 40 40 this to 50 50 paper, to 60 60 to is 70 that70 to 80 almost80 to 90 90 tothree 100 400 8 the0% constituents of our New Economy Index to some of quarters300 of all SOEs in China have a return on equity below CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 80% the broad benchmarks, their growth and quality metrics 10%,200 confirming our thesis that these companies’ finan- Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 70% are superiorNegative to the benchmarks’ constituents as shown in cial100 decisions have little to do with generating sharehold- 60% 0 Figures 11 through 16. For example, per Figure 11, a third of er returns0 to 10 10and to 20 much20 to 30 30to to 40do40 with to 50 50 acting to 60 60 to as70 70agents to 80 80 to on 90 90 behalf to 100 60% 50% the constituents of MarketGrader’s New52% Economy Index the40% Chinese state in its various forms. By comparison, 50% 80% have more than doubled sales in the last three years (in 56%30% and 49% of all companies in the CSI25% 300 Index and 40% 70% fact 12% have more than tripled sales), compared to only the20% MSCI China Index, respectively, had a return on equity 60% 11% 9% 10% 30% 26% 26% 21% for the constituents of the CSI 300 Index, and 26% of below50% 10%. For1% MarketGrader’s New Economy Index, the 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China the constituents of the MSCI China Index. Furthermore, number40% New was Economy only 14%. Greater than 200% Between 100% and 200% Between 0 and 100% Negative half10% of MarketGrader’s7% constituents have at least doubled 30% 25% Figure20% 12. Percentage of Index Constituents with 3-Year their0% operating income in the last three years, compared Operating Income Growth by11% Select Ranges 9% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% to onlyNew 23% Economy of the CSI 300 constituents and 26% of the 50% 1% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 0% constituents in the MSCI China index. And in a clear il- CSI MG China CSI 300 CSI SOE Composite42% MSCI China 40% New Economy 38% lustration of the importance of knowing what to exclude Greater than 200% Between 100% and 200% Between 0 and 100% Negative 800 31% 30% as700 much as knowing what to exclude, Figure 12 shows that

38%600 of CSI 300 companies and 31% of MSCI China’s com- 20%50% panies500 had negative operating income growth in the last 42% 40% 38% 400 10% three years, compared to only 3% of MarketGrader’s New 3% 300 31% 30%0% Economy companies. For the CSI SOE Composite Index, CSI MG China CSI 300 CSI SOE Composite MSCI China 200 New Economy the100 number was 42%. 20% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 0 Operating income growth is measured as the most recent trailing 12-month 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 80% Figure 11. Percentage of Index Constituents with 3-Year Sales figures10% compared to the figures for the 12 months ended three73% years earlier, ex- cluding70% companies in3% the Financial sector. Sources: FactSet, MarketGrader, China Growth by Select Ranges Securities Index Co. 60%0% 80% CSI MG China CSI 300 56%CSI SOE Composite MSCI China New Economy 49% 70% 50% FigureGreater 13. Operatingthan 200% Between Margin, 100% and 200%TrailingBetween 12 0Months, and 100% byNegative Select 60% Ranges40% 80% 50% 30% 73% 70% 20% 40% 14% 60% 56% 30% 25% 10% 50% 49% 20% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 11% 9% 40% 10% New Economy 1% 30% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 0% Between 10% and 20% Less than 10% CSI MG China CSI 300 CSI SOE Composite MSCI China 20% New Economy 14% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 10% Sales growth is measured as the most recent trailing 12-month figures compared to 70% 0% 63% the figures for the 12 months ended three years earlier, excluding companies in the CSI MG China CSI 300 CSI SOE Composite MSCI China Financial sector. Sources: FactSet, MarketGrader, China Securities Index Co. 60% New Economy 50% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 50% Between 10% and 20% Less than 10% 42% 42% 40% 40% 40% 38% Data is as of April, 2020 and excludes all indexes’ constituents in the Financials Not surprisingly, the growth in sales and operating in- sector. Sources: FactSet, MarketGrader, China Securities Index Co. 31% 30%70% come30% described above are also reflected in each index’s 63% 20%60% profitability measures as presented in Figure 13. For Mar- 13% 20% 10%50% ketGrader, 39% of the New Economy constituents had a 42% 40% 0% 10% 40% CSI MG China CSI 300 CSI SOE Composite MSCI China 3% New Economy 8 . The CSI MarketGrader China New Economy Index constituents used 30% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% in this0% paper’s analysis were selected on May 19, 2020, according to the Negative CSI MG China CSI 300 CSI SOE Composite MSCI China 20% Index’s semi-annualNew Economy rebalance methodology, and represent the newly 13% reconstitutedGreater than Index 200% as Betweenof June 100% 15, and 2020. 200% Between 0 and 100% Negative 50%10%

80% 0% MarketGrader 10 MarketGrader Research 73% 40% CSI MG China CSI 300 CSI SOE Composite MSCI ChinaRESEARCH & INDEXES 70% New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 60% 56% 30% Negative 50% 49% 20%50% 40% 15% 30% 10%40% 7% 5% 20% 14% 1% 30%0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% 20% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% CSI MG China CSI 300 CSI SOE Composite MSCI China 15% New Economy Between 10% and 20% Less than 10% Between 40% and 50% Between 30% and 40% Between 20% and 30% Greater than 50% 10% Between 10% and 20% Less than 10% 90% 7% 80% 5% 80% 1% 0% 70% CSI MG China CSI 300 CSI SOE Composite MSCI China 70% New Economy 60% 63% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 60% 50% Between 10% and 20% Less than 10%45% 45% 46% 40% 50% 90% 42% 40% 30% 80% 40% 80% 20% 70% 30% 10% 60% 20% 0% 13% 50% CSI MG China CSI 30045% CSI SOE Composite45% MSCI China46% New Economy 10% 40% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 30% Less than 30% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 40%20% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 35%10% Negative 0% 29% 30% 30% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 50% 25% Greater than 90% Between 70%22% and 90% Between 50% and 70% Between 30% and 50% 20% Less than 30% 40% 40% 15% 35% 10% 30% 30% 30% 29% 5% 20% 25% 15% 0% 22% CSI 300 CSI SOE Composite MSCI China 20% 10% 7% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 5% 15% Less than 4% 1% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 5% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 0% Between 10% and 20% Less than 10% CSI 300 CSI SOE Composite MSCI China 90% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 80% Less than 4% 80% 70% 60% 50 50% 45% 45% 46% Average (all companies) Weighted Average 40% 40.6 40 30% 35.6 35.2 33.0 33.4 20% 30 26.6 27.2 10% 25.3 0% 2050 CSI MG China CSI 300 CSI SOE Composite MSCI China Average (all companies) New Economy Weighted Average 40.6 Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 1040 Less than 30% 35.6 35.2 33.0 33.4 40% 300 26.6 27.2 CSI MG China CSI 300 CSI SOE Composite25.3 MSCI China 35% New Economy 30% 30% 29% 20 25% 22% 10 20% 15% 0 CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy 5% 50% 45% 0% CSI 300 CSI SOE Composite MSCI China 40% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 31% Less than 4% 30% 23% 20%50% 18% 45%

10%40% 31% 30%0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 23% 20% 18%

50 Average (all companies) 10% Weighted Average 40.6 40 35.6 35.2 0% 33.0 33.4 CSI MG China CSI 300 CSI SOE Composite MSCI China 30 27.2 New Economy 26.6 25.3 90% 20 82% 80% 70% 10 62% 63% 60% 51% 0 50% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 40% 90% 30% 82% 80% 20% 70% 63% 10% 62% 60% 0% 51% 50% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 40%

50% 30% 45% 20% 40% 10% 0% 31% CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy 23% 50% 18% 20% 43% 40% 38% 37% 10% 30% 30% 0% 23% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 20%50% 17% 14% 15% 43% 12% 12% 13% 13% 10%40% 38% 37%

30% 30%0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy23% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 20% 17% 14% 15% 12% 12% 13% 13% 90% 82% 10% 80% 70% 0% 62% 63% CSI MG China CSI 300 CSI SOE Composite MSCI China 60% New Economy 51% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 50% 40% 30% 50% 20% 45% 10% 40% 36% 0% 35% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 30%

20%50% 16% 45%

10%40% 36% 35%

30%0% 50% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 43% 20% 16% 40% 38% 37% 10% 30% 30% 110% 102% 100% 23% 0% 90% CSI MG China CSI 300 CSI SOE Composite MSCI82% China 20% 17% 15% 80% New Economy 14% 13% 12% 12% 13% 70% 10% 60% 50% 110% 0% 40% 102% CSI MG China CSI 300 CSI SOE Composite MSCI China 100% New Economy 30% 90% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 20% 15% 82% 80% 10% 6% 70% 0% 60% MG China CSI 300 CSI SOE Composite MSCI China 50% Growth Leaders 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China 50% Growth Leaders 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

Shenzhen 80% Shanghai

China(SZ+SH) 60%

40%

20%

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000 100% 3500 Shenzhen Shenzhen 3000 100%80% Shanghai Shanghai 2500 China(SZ+SH) China(SZ+SH)Shenzhen 60%80% 2000 Shanghai

China(SZ+SH) 1500 40%60% 1000

20%40% 500

0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 20%0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

350% 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 Shenzhen Stock Exchange Composite 4000 300% Shanghai Stock Exchange Composite

3500 250% 4000 Shenzhen 3000 100% Shanghai 200% 3500 2500 China(SZ+SH)Shenzhen 150% 3000 Shenzhen 80% Shanghai 2000 Shanghai 100% 2500 China(SZ+SH) 1500 China(SZ+SH) 60% 50% 2000 1000 1500 0% 40%500 1000 -50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 20%500

0 350% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 0% '99 '01Shenzhen'03 Stock'05 Exchange'07 Composite'09 '11 '13 '15 '17 '19 300% Shanghai Stock Exchange Composite $250 350% CSI SOE Composite Index 250% Shenzhen Stock Exchange Composite CSI All Share Index 4000 300% Shanghai Stock Exchange Composite CSI 300 Index 200% $200 3500 250% Shenzhen 150% 3000 200% Shanghai 100% $150 2500 China(SZ+SH) 150% 50% 2000 100%

15000% $100 50% 1000-50% 12/31/990% 12/31/01 12/31/03 12/30/05 12/28/07 $50 500 -50% 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

$250 50% 350% CSI SOE Composite Index ShenzhenCSI All Share Stock Index Exchange Composite 300%$250 ShanghaiCSI 300 IndexStock Exchange Composite $200 CSI SOE Composite Index 40% 250% CSI All Share Index CSI 300 Index 200%$200 30% $150 150%

20% 100%$150 $100 50% 10%

$1000% $50 -50%3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 0% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China

$50 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10%

3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 Negative

50%

58% $250 60% 50% 40% CSI SOE Composite Index 50% CSI All Share Index 46% 44% CSI 300 Index 40% $20030%40% 30%

20% 16% 20%30% $150 10%

0% 10%20% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy $100 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

10%0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 60%

$50 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 52% 50% 0%3/31/10Negative 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 40% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative 30% 26% 60% 58% 26% 50% 20% 50% 46% 44% 60% 58% 10% 7% 40% 40% 50% 0% 30% 46% 44% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 40% 20% 16% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 30% 30% 10% 800 20% 0% 16% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China 700 New Economy 10% 600 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative 0% 500 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 400 60% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 300 Negative 52% 50%0% 200 MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 60% 100 40% Greater than 30% Between 20% and 30% Between 10% and 20%52% Between 0 and 10% 0 50% 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 Negative 30% 26% 26% 40% 20% 80% 30% 26% 10%60% 7% 58% 26% 70% 20% 60% 50%0% CSI MG China CSI 30046% CSI SOE Composite MSCI China44% 50% 10% New Economy7% 40% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 40% 0% 30% CSI MG China CSI 300 CSI SOE Composite MSCI China 30% 25% New Economy 800 20% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 20% 16% 11% 9% 700 10% 1% 10%600 0% 800 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 5000% 700 CSI MG China CSI 300 CSI SOE Composite MSCI China Greater than 200% Between 100% and 200% Between 0 and 100% Negative 400 New Economy 600 Greater than 30% Between 20% and 30% Between 10% and 20% 300 Between 0 and 10% 500 Negative 200 400 50% 60%100 300 42% 0 52% 40% 38% 50%200 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 31% 100 30% 40% 80%0 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 30% 20% 70% 26% 26%

60%20% 80% 10% 50% 3% 70%10% 7% 40% 0% 60% CSI MG China CSI 300 CSI SOE Composite MSCI China 0% New Economy 30% CSI MG China CSI 300 CSI SOE Composite25% MSCI China 50% New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative 20% 40% Greater than 20% Between 10% and 20% Between 0 and 10% Negative 11% 9% 80% 10% 30% 73% 1% 25% 70% 0% 20%800 CSI MG China CSI 300 CSI SOE Composite MSCI China 60% 56% New Economy 11% 9% 10%700 Greater than 200% Between 100% and 200% Between 0 and 100% Negative 49% 1% 50% 6000% CSI MG China CSI 300 CSI SOE Composite MSCI China 40% 500 New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative 30% 50%400 20% 14% 300 42% 40% 38% 10% 200 50% 0% 31% CSI MG China CSI 300 CSI SOE Composite MSCI China 30%100 42% New Economy 40%0 38% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 20% 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 Between 10% and 20% Less than 10% 31% 30% 10%80% 70% 20% 3% 70% 63% 0% 60% 60% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy 50% 50% 3% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 42% 40% 40% 40%0% 80% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 73% 30% 30% 25% 70% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 20% 20% 60% 56% 13% 80% 11% 9% 10% 50% 73% 49% 10% 70% 1% 0% 40% CSI MG China CSI 300 CSI SOE Composite MSCI China 0% 60% New Economy 56% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 30% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 49% 50% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 20% Negative 40% 14% 10% 30% 50% 50%0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy14% 42% 10% 40% 40% Greater than 50% Between 40% and 50%38% Between 30% and 40% Between 20% and 30% 0% Between 10% and 20% Less than 10% Figure CSI14. MG Return China on Equity,CSI 300 TrailingCSI SOE 12 Composite Months, byMSCI Select China31% 30% 30% New Economy Another source of concern for investors should be the Ranges Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% large stakes the benchmarks own in some of the coun- 70% Between 10% and 20% Less than 10% 20% 20% 63% 15% 60% try’s banks, many of which are highly leveraged, particu- 10% 7% 10% 5% 50%70% larly among SOEs. One of our preferred ways of measur- 3% 42% 63% 1% 40% 0% 40%60%0% ing bankCSI MGleverage China is byCSI 300calculatingCSI SOE whatComposite we callMSCI TangibleChina CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy New Economy 30%50% EquityGreater Ratio, than 50% whichBetween refers 40% and 50% to Betweenthe 30%percentage and 40% Between that 20% and each 30% Greater than 200% Between 100% 42%and 200% Between 0 and 100% Negative 40% Between 10% and 20% Less than 10% 20%40% bank’s non-performing assets represent relative to its 13% 80% 90% 10%30% 73% tangible equity80% and its loss reserves. As shown in Figure 70% 80% 20%0% 17,70% 29% of all banks in the CSI 300 Index have non-per- 60% CSI MG China13% CSI 300 56%CSI SOE Composite MSCI China New Economy 10% 49% forming60% assets that exceed 10% of their tangible equity 50% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative 50% 45% 45% 46% Data40%0% is as of April, 2020 and excludes all indexes’ constituents in the Financials plus their loss reserves, while for the SOE benchmark the CSI MG China CSI 300 CSI SOE Composite MSCI China 40% sector. Sources:New Economy FactSet, MarketGrader, China Securities Index Co. 50%30% number is 22% and, surprisingly, for MSCI China it is 30%. Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 30% Figure20% Negative 15. Gross Profitability, Trailing 12 Months, by Select 14% The20% CSI MarketGrader China New Economy Index doesn’t Ranges40% 10% 10% 50% hold any banks. 0% 0% 30% CSI MG China CSI 300 CSI SOE Composite MSCI China CSI MG China CSI 300 CSI SOE Composite MSCI China 40% New Economy New Economy Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 20% Figure 17. Tangible Equity Ratio, April 2020, by Select Ranges 15%Between 10% and 20% Less than 10% Less than 30% 30% 40% 10% 7% 5% 35% 20%70% 15% 1% 63% 29% 30% 0% 30% 60% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy 7% 25% 5% 22% 50% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 1% 20% Between 10% and 20% Less than 10%42% 40% 40%0% CSI MG China CSI 300 CSI SOE Composite MSCI China 15% 90% New Economy 30% 80% Between 20% and 30% 80% Greater than 50% Between 40% and 50% Between 30% and 40% 10% Between 10% and 20% Less than 10% 70%20% 5% Gross Profitability13% is measured as trailing 12-month sales minues costs of goods sold90% as a percentage of total assets. It excludes all companies in the Financial 60%10% 80% 0% Sector.80% Sources: FactSet, MarketGrader, China Securities Index Co. CSI 300 CSI SOE Composite MSCI China 50% 45% 45% 46% Between 8% and 10% Between 6% and 8% Between 4% and 6% 70%0% Greater than 10% 40% CSI MG China CSI 300 CSI SOE Composite MSCI China Less than 4% Figure60% New16 showsEconomy the stark difference in leverage between 30% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Tangible Equity Ratio is measured as non-performing assets as a percentage to 50% Negative MarketGrader’s20% New Economy45% companies45% and the bench46% - total tangible equity and reserves for loans and asset losses. It is used only for Banks. Sources: FactSet, MarketGrader, China Securities Index Co. 40% marks.10% Whereas for 80% of MarketGrader’s constituents 30%50% 0% total20% debtCSI MG makes China up lessCSI 300 thanCSI 30% SOE ofComposite their capitalMSCI China struc- 40% New Economy ture,10% forGreater the than 90% CSI 300Between and70% and the90% CSIBetween SOE 50% and Composite 70% Between 30% the and 50%fig- Less than 30% Does GARP Work in China? 0% ure30% is 45%,CSI MG while China onlyCSI 46% 300 of theCSI SOEconstituents Composite MSCI of the China MSCI 40% New Economy China35% GreaterIndex than 90% haveBetween less 70% than and 90% 30%Between of 50% their and 70% capitalBetween 30%as and debt. 50% 50 20% Less than 30% While absoluteAverage (all valuationcompanies) multiples such as price to earn- 15% 30% And30% 11%29% of the CSI SOE Composite Index constituents Weighted Average 40% ings, price to book, price to sales40.6 and price to cash flow ra- 10% 40 have25% a capital structure22% where debt accounts7% for at least 35.6 35.2 35% 5% tios are33.0 useful to help investors understand33.4 the price the 20% 1% 30% 30% 29% 30 27.2 70%0% of total capital. 26.6 25.3 15% CSI MG China CSI 300 CSI SOE Composite MSCI China market is willing to pay for a particular company’s stock, 25% New Economy 22% 20 Figure10% Greater 16. Totalthan 50% DebtBetween as 40%a Percentage and 50% Between of 30% Total and 40% CapitalBetween by20% Selectand 30% they lack context. This is especially true when compar- 20% Between 10% and 20% Less than 10% Ranges5% 15% ing10 companies of different sizes and business models 90% 0% 80% 80%10% CSI 300 CSI SOE Composite MSCI China that operate in different industries and sectors and in Between 8% and 10% Between 6% and 8% Between 4% and 6% 0 70%5% Greater than 10% differentCSI MG countries. China CSI Peer 300 averagesCSI SOE Composite help toMSCI provide China some Less than 4% New Economy 60%0% CSI 300 CSI SOE Composite MSCI China context but don’t tell the whole story, since they don’t 50% Greater than 10% Between 8% and 10%45% Between 6% and 8%45% Between 4% and 6%46% 40% Less than 4% tell us much about the value of a company’s underlying 30% business; or, more specifically, about the growth under- 20% lying such business. This is where GARP is useful, since it 10% 0% looks50% at a stock’s valuation in the context of the growth CSI MG China CSI 300 CSI SOE Composite MSCI China 45% New Economy in its underlying business, through the lens of funda- 50 Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 40% Less Averagethan 30% (all companies) mentals such as sales, cash flow and net income. It is a Weighted Average 31% Data40% is as of April, 2020 and excludes all indexes’40.6 constituents in the Financials sector.40 Sources: FactSet, MarketGrader, China Securities Index Co. 30% 35.6 35.2 35% 23% 50 33.0Average (all companies) 33.4 30% 18% 30%30 29%Weighted Average 27.2 20% 26.6 40.6 25.3 MarketGrader 1140MarketGrader Research RESEARCH & INDEXES 25% 35.6 35.2 20 33.0 22% 33.4 10% 20%30 27.2 26.6 25.3 15% 0% 10 CSI MG China CSI 300 CSI SOE Composite MSCI China 10%20 New Economy 0 5% CSI MG China CSI 300 CSI SOE Composite MSCI China 10 New Economy 0% CSI 300 CSI SOE Composite MSCI China 0 Between 4% and 6% CSIGreater MG than China 10% BetweenCSI 8%300 and 10%CSI SOEBetween Composite 6% and 8% MSCI China NewLess than Economy 4%

90% 82% 80% 50% 45% 70% 62% 63% 60% 40% 51% 50% 50% 45% 31% 30% 40% 40% 23% 30% 50 Average (all companies) 20% 18% 20% Weighted Average 40.6 31% 30%40 10% 35.6 35.2 10% 33.0 23% 33.4 0% 18% CSI MG China CSI 300 CSI SOE Composite MSCI China 20%30 27.2 26.6 25.3 New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 10%20 New Economy

0% 10 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 50% 43% 40% 38% 37% 90% 82% 30% 80% 30% 70% 63% 23% 90% 62% 60% 82% 20% 17% 80% 51% 14% 15% 50% 13% 13% 50% 12% 12% 70% 45% 40% 62% 63% 10% 60% 30%40% 51% 50% 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China 31% New Economy 30%40% 10% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 30% 0% 23% 20% CSI MG China CSI 300 CSI SOE 18%Composite MSCI China 20% New Economy 10% 10%0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 50% 43% 45% 40% 38% 37% 40% 36% 50% 35% 30% 30% 43% 30% 40% 23% 38% 37% 90% 20% 17%82% 20% 80% 14% 30% 15% 16% 30% 12% 12% 13% 13% 70% 23% 10% 62% 63% 10% 20%60% 17% 14% 51% 15% 50%0% 13% 13% CSI MG China CSI12% 300 CSI SOE12% Composite MSCI China 0% 10% New Economy CSI MG China CSI 300 CSI SOE Composite MSCI China 40% New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 30% 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 10% PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 110% 102% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 100% New Economy 90% 82% 80% 70% 60% 50% 50% 45% 40% 30% 40% 20% 15% 36% 35% 50% 10% 6% 45% 43% 0% 30% MG China CSI 300 CSI SOE Composite MSCI China 40% 38% 37% Growth Leaders 36% 35% 20% 16% 30% 30% 23% 10% 20% 17% 16% 14% 15% 0% 12% 12% 13% 13% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy

0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy 110% PEG Between102% 0 and 1 PEG Between 1 and 2 PEG Greater than 2 100% 90% 82% 80% 110% 102% 100%70% 60% 90% 82% 50%80% 40%70% 30%60% 15% 20%50% 10%50% 6% 40% 45% 0% 30% MG China CSI 300 CSI SOE Composite MSCI China 40%20% Growth Leaders 15% 36% 35% 10% 6% 0% 30% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100%

100% Shenzhen 80% Shanghai Shenzhen 80% China(SZ+SH) 60% Shanghai

China(SZ+SH) 60% 40%

40% 20%

20% 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000

35004000 Shenzhen 30003500 Shanghai Shenzhen 25003000 China(SZ+SH) Shanghai

20002500 China(SZ+SH)

15002000

10001500

1000500

5000 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 350% Shenzhen Stock Exchange Composite 300%350% Shanghai Stock Exchange Composite Shenzhen Stock Exchange Composite 250%300% Shanghai Stock Exchange Composite

200%250%

150%200%

100%150%

100%50%

50%0%

-50%0% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 -50% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 100%

Shenzhen 80% $250 Shanghai CSI SOE Composite Index China(SZ+SH) $250 CSI All Share Index 60% CSI 300SOE IndexComposite Index $200 CSI All Share Index CSI 300 Index 40% $200

$150 20%

$150

0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 $100

$100

4000 $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 3500 $50 Shenzhen 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 3000 Shanghai

2500 China(SZ+SH) 50%

2000 50% 40% 1500 40% 1000 30%

500 30%

0 20% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 20%

10% 350% Shenzhen Stock Exchange Composite 10% 300% Shanghai Stock Exchange Composite 0% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 250% 0% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 200% Negative Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10%

Negative 150%

60% 58% 100% 50% 58% 60% 46% 44% 50% 50%40% 46% 44% 0% 40%30%

-50% 20% 16% 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 30%

20%10% 16%

0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% NegativeCSI MG China CSI 300 CSI SOE Composite MSCI China $250 New Economy Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% CSI SOE Composite Index Negative 60% CSI All Share Index 52% CSI 300 Index 60%50% $200 52% 50%40%

40%30% 26% 26% $150 20% 30% 26% 26%

20%10% 7%

0% $100 10% CSI MG China7% CSI 300 CSI SOE Composite MSCI China New Economy 0% Between 10% and 20% Negative GreaterCSI MG than China20% CSI 300 CSIBetween SOE 0 Compositeand 10% MSCI China New Economy $50 Greater than 20% Between 10% and 20% Between 0 and 10% Negative 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 800 700 800 600 700 500 600 50% 400 500 300 400 200 40% 300 100 200 0 100 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 30% 0 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 80%

20% 70% 80% 60% 70% 50% 60% 10% 40% 50% 30% 25% 40% 20% 0% 30% 11% 25% 9% MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China 10% 20% 1% Between 10% and 20% Greater than 30% Between 20% and 30% Between 0 and 10% 0% 11% 9% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China Negative New Economy1% 0% Greater than 200% Between 100% and 200% Between 0 and 100% Negative CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative 60% 58% 50% 50% 46% 44% 42% 40%50% 38% 40% 42% 31% 40% 38% 30% 30% 31% 20% 16% 20%30%

10% 10%20% 3% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy 0% CSI MG China3% CSI 300 CSI SOE Composite MSCI China Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% New Economy Negative 0% Greater than 200% Between 100% and 200% Between 0 and 100% Negative CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 80% 60% Greater than 200% Between 100% and 200% Between 0 and73% 100% Negative 52% 70% 80% 50% 60% 56% 73% 70% 49% 40% 50% 60% 56% 40% 49% 30% 26% 26% 50% 30% 40% 20% 20% 30% 14% 10% 7% 10% 20% 0% 14% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy New Economy 0% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% CSI MG China CSI 300 CSI SOE Composite MSCI China Greater than 20% Between 10% and 20% Between 0 and 10% Negative BetweenNew Economy 10% and 20% Less than 10% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10% 800 70% 63% 700 60% 70% 600 63% 50% 60% 500 42% 40% 40% 400 50% 30% 42% 40% 300 40% 200 20% 30% 13% 100 10% 20% 13% 0 0% 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% NegativeCSI MG China CSI 300 CSI SOE Composite MSCI China 80% New Economy 70% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 50% Negative 60%

50% 40%50% 40% 30%40% 30% 25%

20% 20%30% 11% 9% 15% 10% 1% 20% 0% 10% 15% 7% CSI MG China CSI 300 CSI SOE Composite MSCI China 5% New Economy 1% Greater than 200% Between 100% and 200% Between 0 and 100% Negative 10%0% 7% CSI MG China 5% CSI 300 CSI SOE Composite MSCI China New Economy 1% 0% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% BetweenCSI MG 10% China and 20% LessCSI than 300 10% CSI SOE Composite MSCI China New Economy 50% 90% Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% 42% Between 10% and80% 20% Less than 10% 40% 38% 80% 90% 70% 80% 31% 80% 30% 60% 70% 50% 45% 45% 46% 60% 20% 40% 50% 30% 45% 45% 46% 10% 40% 20% 3% 30% 10% 0% 20% CSI MG China CSI 300 CSI SOE Composite MSCI China 0% New Economy CSI MG China CSI 300 CSI SOE Composite MSCI China 10% New Economy Greater than 200% Between 100% and 200% Between 0 and 100% Negative 0% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% LessCSI than MG 30% China CSI 300 CSI SOE Composite MSCI China 80% New Economy 73% 40% Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% 70% Less than 30% 35% 60% 56% 40% 29% 30% 49% 30% 50% 35% 25% 30% 40% 30% 29% 22% 20% 30% 25% 15% 22% 20% 14% 20% 10% 10% 15% 5% 0% 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% 5% CSI 300 CSI SOE Composite MSCI China Greater than 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Between 10% and 20% Less than 10% 0% Less than CSI4% 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4% 70% 63% 60%

50% 42% 40% 40%

30%

20% 50 13% Average (all companies) 10% Weighted Average 40.6 4050 Average (all companies) 35.6 35.2 0% 33.0Weighted Average 33.4 CSI MG China CSI 300 CSI SOE Composite MSCI China 40.6 New Economy 3040 27.2 35.6 35.2 26.6 25.3 Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% 33.0 33.4 Negative 2030 27.2 26.6 25.3 50% 1020

40% 100 CSI MG China CSI 300 CSI SOE Composite MSCI China 30% New Economy 0 CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 20% 15% methodology that instead of focusing on stock valuations China New Economy are growing at a much faster rate 10% 7% 5% first, analyzes companies in a way1% that is always tethered than those of the other benchmarks (Figures 19 and 20). 0% to growth,CSI MG affordingChina CSI investors 300 CSI flexibilitySOE Composite insteadMSCI China of rig- New Economy 50% Figure 19.45% 1-Year Trailing EPS Growth, Weighted Average idly adheringGreater than 50% to fixedBetween 40% valuation and 50% Between multiples. 30% and 40% InBetween the 20% case and 30% of Between 10% and 20% Less than 10% 50%40% the Chinese equity universe, this approach is particularly 45% 90% 31% 80% useful80% given the dichotomy described earlier, between the 40%30% 23% country’s70% rapid economic growth and the poor economic 31% 30%20% 18% 60% returns generated by a large portion of its publicly traded 23% 50% 45% 45% 46% 20%10% 18% companies.40% GARP—along with quality metrics—allows us to30% identify companies that are harnessing the country’s 10%0% CSI MG China CSI 300 CSI SOE Composite MSCI China 20% rapid growth rates, across all sectors, while ensuring that New Economy 10% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China the0% stock prices of these companies are trading in line New Economy CSI MG China CSI 300 CSI SOE Composite MSCI China with theirNew Economy growth expectations. A useful metric in iden- Sources: FactSet, MarketGrader, China Securities Index Co. Greater than 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% Less than 30% tifying relative value is the PEG ratio, which measures not Figure 20. Percentage of Companies with Positive 1-Yr. Trail- 40% just the stock’s price relative to its earnings but rather to ing EPS Growth by Index 35% its earnings growth. 30% 90% 30% 29% 82% 80% 25% 22% 70%90% 82% 62% 63% A20% cursory analysis of the stock valuations of MarketGrad- 60%80% 70% 51% er’s15% New Economy constituents shows that, based on the 50% 62% 63% 60% 10% 40% 51% average trailing price to earnings (P/E) ratios, the Index 50% 5% 30% itself is not that much cheaper than the benchmarks. In 20%40% 0% fact, as shownCSI 300 in FigureCSI 18, SOE the Composite weighted P/EMSCI ratio China (based 10%30% Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% 20%0% Less than 4% on the weights of each index’s constituents) of Market- 10% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% Grader’s Index appears marginally more expensive than Sources:CSI FactSet, MG China MarketGrader,CSI 300 China SecuritiesCSI SOE CompositeIndex Co. MSCI China the CSI 300 Index, the CSI SOE Composite, and the MSCI New Economy China Index. The growth rates shown above provide the context for the evaluation of the CSI MarketGrader China New Econo-

my50% Index and the benchmarks from a value perspective Figure 18. Average Trailing P/E Ratios that is43% more useful than looking at standalone P/E ratios. 50% 50 Average (all companies) 40% 38% 37% Weighted Average When43% combining P/E ratios with the earnings growth 40.6 30% 40 30%40% 38% 37% 35.6 35.2 rates (based on trailing growth) of each index’s constit- 33.0 33.4 23% 30% uents,30% the differences are clear. Among all members of 30 26.6 27.2 20% 17% 25.3 23% 14% 15% the MarketGrader New12% Economy,12% 43%13% have 13%a PEG ratio 20 10%20% 17% 14% 15% between zero (0) and12% one (1), which12% 13% is considered13% a very 10 10%0% attractiveCSI MG valuation China CSIrelative 300 CSIto SOEthe Composite companies’MSCI Chinaunderlying New Economy PEG Between 0 and 1 0 growth0% rate. Put differently,PEG Between 1 and 2 almostPEG Greater halfthan 2 of MarketGrad- CSI MG China CSI 300 CSI SOE Composite MSCI China CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy er’s constituentsNew Economy are valued at less than one unit of P/E for PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 Sources: FactSet, MarketGrader, China Securities Index Co. every unit of earnings growth. By comparison, the percentage of companies in the CSI 300, CSI SOE Composite However, as described earlier, all of these indexes are and MSCI China indexes with PEGs between zero and one comprised of very different types of companies with very are 38%, 30% and 37%, respectively. This is presented in 50% different fundamental profiles and, more importantly, Figure50% 21. Figure 22 presents the percentage of companies 45% 45% very40% different growth rates in their underlying business- with negative PEGs by index. Since the PEGs are only cal- 40%50% 36% 45% es. In fact, when looking at earnings per share31% growth, culated for companies with positive P/Es it follows35% that 30% 30%40% 36% it is clear that the constituents23% of the CSI MarketGrader if a company has a negative PEG ratio it has35% a negative 18% 20% trailing30% 12-month earnings per share growth. 20% 16%

10% 10%20% 16%

0% 10% MarketGrader 12 MarketGraderCSI MG China ResearchCSI 300 CSI SOE Composite MSCI China 0% RESEARCH & INDEXES New Economy CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 110%90% 102% 82% 100%80% 70% 90% 90% 82% 82% 80%60% 80% 70%50% 70% 40% 62% 63% 60% 60% 50%30% 51% 15% 50% 40%20% 30%10% 6% 40% 20%0% 15% 30% MG China CSI 300 CSI SOE Composite6% MSCI China 10% Growth Leaders 20% 0% MG China CSI 300 CSI SOE Composite MSCI China 10% Growth Leaders 0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

50% 43% 40% 38% 37%

30% 30% 23% 20% 17% 14% 15% 12% 12% 13% 13% 10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2

50% 45%

40% 36% 35%

30%

20% 16%

10%

0% CSI MG China CSI 300 CSI SOE Composite MSCI China New Economy

110% 102% 100% 90% 82% 80% 70% 60% 50% 40% 30% 20% 15% 10% 6% 0% MG China CSI 300 CSI SOE Composite MSCI China Growth Leaders 100% 100%

Shenzhen 80% Shenzhen 80% Shanghai Shanghai China(SZ+SH) 60% China(SZ+SH) 60%

40% 40%

20% 20%

0% 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

4000 4000 3500 3500 Shenzhen Shenzhen 3000 3000 Shanghai Shanghai 2500 China(SZ+SH) 2500 China(SZ+SH) 2000 2000 1500 1500 1000 1000 500 500 0 0 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

350% 350% Shenzhen Stock Exchange Composite Shenzhen Stock Exchange Composite 300% Shanghai Stock Exchange Composite 300% Shanghai Stock Exchange Composite 250% 250%

200% 200%

150% 150%

100% 100%

50% 50%

0% 0%

-50% -50%12/31/99 12/31/01 12/31/03 12/30/05 12/28/07 12/31/99 12/31/01 12/31/03 12/30/05 12/28/07

$250 $250 CSI SOE Composite Index CSI SOE Composite Index CSI All Share Index CSI All Share Index CSI 300 Index $200 CSI 300 Index $200

$150 $150

$100 $100

$50 $50 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20 3/31/10 3/30/12 3/31/14 3/31/16 3/30/18 3/31/20

50% 50%

40% 40%

30% 30%

20% 20%

10% 10%

0% 0%MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China MG China Growth Leaders CSI 300 CSI SOE Composite MSCI China Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Greater than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative Negative

60% 58% 60% 58%

50% 46% 50% 44% 46% 44% 40% 40% 30% 30% 20% 16% 20% 16% 10% 10% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew Economythan 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% GreaterNegative than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

60% 60% 52% 50% 52% 50% 40% 40%

30% 26% 26% 30% 26% 26% 20% 20% 10% 7% 10% 7% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy Greater than 20% Between 10% and 20% Between 0 and 10% Negative Greater than 20% Between 10% and 20% Between 0 and 10% Negative

800 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 0 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100 0 to 10 10 to 20 20 to 30 30 to 40 40 to 50 50 to 60 60 to 70 70 to 80 80 to 90 90 to 100

80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 25% 30% 25% 20% 20% 11% 9% 10% 11% 9% 10% 1% 0% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew thanEconomy 200% Between 100% and 200% Between 0 and 100% Negative Greater than 200% Between 100% and 200% Between 0 and 100% Negative

50% 50% 42% 40% 38% 42% 40% 38% 31% 30% 31% 30%

20% 20%

10% 10% 3% 3% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew Economythan 200% Between 100% and 200% Between 0 and 100% Negative Greater than 200% Between 100% and 200% Between 0 and 100% Negative 80% 80% 73% 70% 73% 70% 60% 56% 60% 56% 50% 49% 50% 49% 40% 40% 30% 30% 20% 20% 14% 10% 14% 10% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew Economythan 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% BetweenGreater than 10% 50% and 20% BetweenLess 40% than and 10% 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10%

70% 70% 63% 60% 63% 60% 50% 50% 42% 40% 40% 42% 40% 40% 30% 30% 20% 20% 13% 10% 13% 10% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew thanEconomy 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% GreaterNegative than 30% Between 20% and 30% Between 10% and 20% Between 0 and 10% Negative

50% 50%

40% 40%

30% 30%

20% 20% 15% 15% 10% 7% 10% 5% 7% 5% 1% 0% 1% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew Economythan 50% Between 40% and 50% Between 30% and 40% Between 20% and 30% GreaterBetween than 10% 50% and 20% BetweenLess 40% than and 10% 50% Between 30% and 40% Between 20% and 30% Between 10% and 20% Less than 10% 90% 90% 80% 80% 80% 80% 70% 70% 60% 60% 50% 45% 45% 46% 50% 45% 45% 46% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China GreaterNew thanEconomy 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% LessGreater than than 30% 90% Between 70% and 90% Between 50% and 70% Between 30% and 50% Less than 30% 40% 40% 35% 35% 29% 30% 30% 30% 30% 29% 25% 22% 25% 20% 22% 20% 15% 15% 10% 10% 5% 5% 0% 0% CSI 300 CSI SOE Composite MSCI China CSI 300 CSI SOE Composite MSCI China Greater than 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% GreaterLess than than 4% 10% Between 8% and 10% Between 6% and 8% Between 4% and 6% Less than 4%

50 Average (all companies) 50 Average (all companies) Weighted Average 40.6 40 Weighted Average 40.6 40 35.6 35.2 33.0 35.6 35.2 33.4 33.0 33.4 30 26.6 27.2 30 25.3 27.2 26.6 25.3 20 20

10 10

0 0 CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy

50% 50% 45% 45% 40% 40% 31% 30% 31% 30% 23% 23% 20% 18% 20% 18%

10% 10%

0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy

90% 90% 82% 80% 82% 80% 70% 63% 70% 62% 60% 62% 63% 60% 51% 50% 51% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy

Figure 21. Distribution of PEG Ratios by Index Figure 23. MarketGrader Ratings Breakdown by Index, May 50% 2020 50% 43% 43% 100% 40% 38% 37% 40% 38% 37% 30% 80% 30% 30% 30% 23% 23% 60% 20% 17% 20% 17% 14% 15% 12% 12% 13% 13% 15% 14% 13% 40% 10% 12% 12% 13% 10% 20% 0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China 0% PEGNew Between Economy 0 and 1 PEG Between 1 and 2 PEG Greater than 2 CSI MG China CSI SOE Composite CSI 300 Index MSCI China PEG Between 0 and 1 PEG Between 1 and 2 PEG Greater than 2 New Economy SELL HOLD BUY Sources: FactSet, MarketGrader, China Securities Index Co. Source: MarketGrader

Figure 22. Percentage of Companies With Negative PEG Ratios by Index

50% 50% 45% 45% 40% 36% 40% 35% 36% 35% 30% 30%

20% 16% 20% 16% 10% 10%

0% 0% CSI MG China CSI 300 CSI SOE Composite MSCI China NewCSI MG Economy China CSI 300 CSI SOE Composite MSCI China New Economy Sources: FactSet, MarketGrader, China Securities Index Co.

110% 102% 100%110% 102% 100% As90% described earlier, MarketGrader measures82% companies’ 80%90% 82% fundamental70%80% strength from a GARP perspective, through 60%70% 2450%60% fundamental indicators. Each one of these offers a 50% unique40% snapshot into a certain area of each company’s 30%40% fundamentals.20%30% However,15% what is usually most challeng- 15% 10%20% 6% 6% ing10%0% for investors is putting all of these snapshots together 0% MG China CSI 300 CSI SOE Composite MSCI China into aGrowth cohesiveMG China Leaders frameworkCSI 300 thatCSI SOE helps Composite themMSCI decide, China sim- Growth Leaders ply, whether to buy a stock or not. Providing that frame- work and painting a clear picture of a given company’s investment prospects, from the perspective of GARP, is what MarketGrader’s Score (MG ScoreTM) was designed to do, which is why it is the primary factor determining a company’s inclusion to a MarketGrader index. In China this is particularly useful given the prevalence of under- performing SOEs in the equity market. Figure 24 presents a breakdown of China’s benchmarks by MG ScoreTM. This figure offers a succinct summary of the quality of each of the indexes based on the financial and economic strength of the companies that constitute each of the indexes.

MarketGrader 13 MarketGrader Research RESEARCH & INDEXES Conclusion

In just three decades China’s equity markets have evolved significantly from their humble origins in the 1990s. However, they still exhibit many of the structural deficiencies germane to emerging markets. Investors often attribute the excessive equity market volatility and inconsistent returns to a lack of understanding by Chinese retail investors as to the merits of long-term investing together with a dearth of broad institutional ownership that is typical in developed equity markets. And while speculation is indeed rampant among Chinese investors, the fact remains that in a market that is now the second largest in the world, too few retail investors own stocks to make much of a difference in stock performance.

MarketGrader’s research shows that many of the problems that still plague China’s equity markets can be traced to the dual ownership structure promoted by the government in the early days of China’s privatization drive. This, coupled with strict capital controls that forced many of China’s most promising companies to list outside Mainland China’s exchanges, created an investment culture of insiders versus outsiders, where the insiders are the central and local governments who are still majority owners of more than half of all companies listed publicly in China’s domestic exchanges (SOEs). It is not a coincidence that these SOEs were the drivers of much of China’s industrialization drive that made the country a manufacturing powerhouse in less than four decades. They are the resource-heavy, old-line industrial companies in the materials, oil & gas, utilities and manufacturing sectors along with the state-owned banks that continue to fuel their growth with credit that is essentially backed by the state. Consequently, these SOEs grew in size to rival some of the largest companies in the world and as a result came to dominate the market cap-weighted indices that investors have used for years as benchmarks for China’s stock market.

There is, however, a newer crop of private companies in China that have grown alongside the SOEs segment of the country’s equity market. While not all are exclusively so-called ‘new economy’ companies, many of them are consumer-facing, service providers or high valued-added manufacturers in areas such as semiconductors, networking equipment and In- ternet infrastructure. In an era of deglobalization, these Chinese companies stand to benefit the most from the country’s continued rise to developed market status on the back of a massive middle class with rising disposable incomes. Identifying and gaining exposure to these companies requires indexes that incorporate a stock selection methodology founded on the concepts of quality fundamentals. It also requires long-term thinking, particularly at a time when investors might be reevaluating their China exposure based on geopolitical tensions. While this political conflict will be with us for years, the benefits from China’s ongoing economic growth will continue to accrue to the country’s best companies, especially if foreign firms disengage from the country in the next few years. Therefore, it is incumbent upon investors to decide how to best participate in China’s domestic growth and benchmark their exposure to Chinese equities. The CSI MarketGrader China New Economy Index, which collects the country’s most fundamentally sound companies in the economy’s fastest growing areas, and largely excludes SOEs as a an outcome of selection, might be one such benchmark.

MarketGrader 14 MarketGrader Research RESEARCH & INDEXES Carlos Diez

Carlos founded MarketGrader in 1999 and built a quantitative research engine to rate public companies using a fundamentals-based scoring system that follows a growth-at-a- reasonable-price (GARP) methodology. In 2003 the firm developed a family of U.S. equity indexes, with stock selection based on MarketGrader’s fundamental scores, weighing all constituents equally rather than by market capitalization. MarketGrader then partnered with Barron’s and Dow Jones Indexes in 2006 to construct the Barron’s 400 Index, which collects the most fundamentally attractive companies in the U.S. The Barron’s 400 Index was the basis of the Barron’s 400 ETF (NYSE: BFOR), which was successfully launched in partnership with ALPS Advisors in 2013. In 2017, MarketGrader partnered with China Se- curities Index Co. to develop next-generation indexes for China’s A-share market. Today MarketGrader rates 35,000 public companies in 93 countries and publishes over 50 global indexes utilizing its proprietary GARP methodology.

Carlos earned a BS in Economics from Pepperdine University.

Carlos Diez CEO and Founder MarketGrader.com Corp. [email protected] Information herein is provided for general informational purposes and not intended to be completely comprehensive regarding the particular subject matter. MarketGrader.com Corp. does not represent, guarantee, or provide any warranties (express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Receipt of information does not create an adviser-client relationship between MarketGrader.com Corp. and you. Neither MarketGrader.com Corp. nor our advisory affiliates provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation.

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