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TAPPING INTO A BROADER RANGE OF INVESTMENT OPPORTUNITIES AS MARKET OPENS UP Tapping into a broader range of investment opportunities as China market opens up | November 2018

RISK FACTORS This document is a financial promotion for The First State China Strategy. This information is for professional and institutional investors only in the EEA and elsewhere where lawful. Investing involves certain risks including: • The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested. • Currency risk: Changes in exchange rates will affect the value of assets which are denominated in other currencies. • Single country / specific region risk: Investing in a single country or specific region may be riskier than investing in a number of different countries or regions. Investing in a larger number of countries or regions helps spread risk. • China market risk: Investing in the Chinese market involves risks such as legal, regulatory and economic risks. The securities markets in China may be subject to greater uncertainty than investments in more developed countries. • Concentration risk: Investments are made in a relatively small number of companies or countries which may be riskier than if investments are made in a larger number of companies or countries. • Emerging market risk: Emerging markets may not provide the same level of investor protection as a developed market; they may involve a higher risk than investing in developed markets. Reference to specific securities or companies (if any) are included to explain the investment strategy and should not be construed as investment advice, or a recommendation to invest in any of those companies. For a full description of the terms of investment and the risks please see the Prospectus and Key Investor Information Document for each Fund. If you are in any doubt as to the suitability of our funds for your investment needs, please seek investment advice.

1 Tapping into a broader range of investment opportunities as China market opens up | November 2018

Introduction stock exchanges such as New York and China’s onshore stock market, particularly Kong and denominated in foreign the A-shares segment, is much larger The China equity market includes a currencies, while ‘onshore’ Chinese than the offshore component, with myriad of share classes, each with equities are listed on the Shanghai more than 3,600 companies listed on distinct characteristics. ‘Offshore’ and Shenzhen Stock Exchanges and the Mainland exchanges, compared to Chinese equities are listed on overseas denominated in RMB. around 1,200 listed offshore. Foreign Total Number investment Currency market cap of stocks restrictions Chinese companies incorporated in mainland A Shares China and listed on the Shanghai and Shenzhen RMB 3,556 Yes, but easing stock exchanges US$6.4 Onshore Chinese companies incorporated in mainland trillion B Shares China and listed on the Shanghai and Shenzhen USD 99 No stock exchanges Chinese companies incorporated in mainland H Shares HKD 262 No China and listed in State-owned Chinese companies incorporated US$2.4 Red Chips outside and listed in Hong HKD 164 No trillion Offshore Kong Chinese companies incorporated outside P Chips HKD 694 No mainland China and listed in Hong Kong Chinese companies incorporated outside US$1.0 N Shares USD 165 No mainland China and listed in New York trillion US$9.8 Total China Market 4,940 trillion

Source: Hong Kong Exchanges and Clearing (HKEX), NASDAQ, as at 31 October 2018

Evolving China market access and eligible securities had expanded The launch of the Shenzhen-Hong Kong significantly. Stock Connect followed at the end of Despite the size of China’s onshore 2016; and at the same time, aggregate However, it was the 2014 launch of the equity market, its shares are largely trading quotas were removed (but Stock Connect platform which marked underrepresented in global portfolios. A daily trading limits have remained). In a step-change for overseas investors. closed economy and a history of capital early-2018, daily quotas quadrupled With Stock Connect, access to the controls meant that foreign investors from RMB 13 billion to RMB 52 billion China A-share market became much have, in the past, had little opportunity for Northbound trading; and from more straightforward. to participate in the market. RMB 10.5 billion to RMB 42 billion for Although the launch of the Qualified Stock Connect provided a link between Southbound trading. the Shanghai and Hong Kong stock Foreign Institutional Investor (QFII) Stock Connect now covers around 80% exchanges, allowing foreign investors programme in 2002 permitted a of the market capitalisation of the to trade selected A-share stocks on a small number of overseas investors to Shanghai and Shenzhen exchanges – daily basis without needing to apply purchase China A-shares, trading was or around 1,400 companies. Foreign for individual quotas, or be subject to subject to strict preapprovals, licenses ownership of China A-shares has risen minimum lock-up periods and capital and quotas. steadily (total shareholding value of repatriation limits. It also allowed Mainland companies via Stock Connect Restrictions have eased over time; Mainland investors to diversify their has grown to RMB621 billion1) and and by the time of the launch of the equity holdings and foreign exchange trading volumes have reached record Renminbi-QFII programme in 2011, exposure by purchasing Hong Kong- highs. the number of qualifying investors listed stocks.

Stock Connect Northbound Stock Connect Southbound RMB42 billion trading: Hong-Kong-based trading: Mainland China- daily trading RMB52 billion investors, trading securities based investors, trading quota daily trading listed on the Shanghai and securities listed on the Hong quota Shenzhen stock exchanges Kong stock exchange

1 Source: Hong Kong Exchanges and Clearing (HKEX) as at 31 October 2018 2 Tapping into a broader range of investment opportunities as China market opens up | November 2018

SB record of NB record of HKD43.8bn RMB36.2bn on on 6 Feb 2018 19 June 2018 60 Stock Connect Average Daily Trading Volume (HKD bn) 8.4%

6.4% 6.3%6.4% 51.4 6.1%6.0% 6.1% 6.0% 6.0% 50 5.8% 5.8%5.7% 5.5% 5.7% 5.4% 5.2% 5.2% 7.4 5.0%5.0% 5.2% 4.8% 43.8 4.8% 4.3% 4.0% 38.3 39.7 6.5 39.4 40 3.4% 37.4 3.1% 3.2% 3.1% 3.2% 3.2 34.7 35.4 4.9 2.3% 16.9 5.2 32.6 32.6 2.0% 5.9 1.8% 1.9% 4.5 4.8 6.6 1.5%1.7% 1.7%1.6% 1.5% 1.6% 29.6 1.3% 7.6 4.0 4.0 29.6 30 1.0%1.1% 1.2% 27.5 14.0 0.8% 0.9% 8.6 3.0 0.5% 0.6% 3.8 0.5% 23.9 10.0 7.9 23.1 3.5 10.2 6.1 6.8 21.5 5.8 11.4 19.5 3.3 11.1 11.3 18.6 18.9 9.3 20 17.2 17.5 2.3 8.0 9.5 11.4 15.9 15.4 15.9 1.7 2.2 10.4 10.0 8.8 8.9 12.4 4.4 14.1 1.4 1.4 8.3 9.8 1.7 7.9 8.7 11.7 12.0 1.0 7.1 5.4 4.2 6.1 6.8 7.6 7.2 9.4 9.4 0.5 9.9 7.1 8.6 8.9 6.6 10 7.7 7.2 7.5 7.6 7.4 7.3 7.8 7.4 0.5 6.9 5.6 6.6 6.4 1.6 6.4 6.3 5.0 4.8 1.0 2.4 5.6 5.3 5.7 8.0 3.8 4.4 4.1 16.0 16.0 1.5 14.2 1.7 1.8 5.0 4.6 4.1 3.9 13.8 13.1 0.8 0.8 11.1 1.7 2.4 4.1 3.8 1.7 2.9 11.3 11.6 12.4 12.5 13.011.918.2 10.8 10.5 2.1 2.6 2.1 4.0 2.9 1.6 2.1 8.9 9.3 7.6 7.8 7.0 2.0 2.5 6.7 5.9 6.2 5.6 5.5 5.8 5.8 5.0 4.8 4.7 5.9 5.4 5.7 5.6 6.4 3.6 3.8 3.3 3.5 2.5 3.3 3.4 3.7 3.7 3.6 4.3 3.7 4.2 0 8 7 6 5 8 7 6 5 8 18 17 16 15 18 17 16 15 18 18 17 16 15 r-18 r-17 r-16 r-15 v-17 v-16 v-15 v-14 c-17 c-16 c-15 c-14 g-17 g-16 g-15 p-17 p-16 p-15 n- n- n- n- n- n- n- n- Jul- Jul- Jul- Jul- Ja Ja Ja Ja Ju Ju Ju Ju Ap Ap Ap Ap Feb-1 Feb-1 Feb-1 Feb-1 Oct-17 Oct-16 Oct-15 Se Se Se Mar-18 Mar-17 Mar-16 Mar-15 No No No No Sep- Oct-18 De De De De Au Au Au May-1 May-1 May-1 May-1 Aug-1

Shenzhen Southbound Shenzhen Northbound(1) Total average daily trading volume Shanghai Southbound Shanghai Northbound (1) Percentage of Southbound turnover of Hong Kong Market (1) refers to Hong Kong Exchanges and Clearing (HKEX) Stock Connect, data as at 31 October 2018.

China A-share inclusion in milestone. A further consultation is currently designated by the FTSE China underway, which could lead to a rise in A Stock Connect All Cap Index. After equity indices the PIF from 5% to 20% for large-cap completion of the first tranche, China securities in 2019; ChiNext stocks to be A-shares will comprise approximately Global investors can now choose to added to the eligible exchanges in 2019; 5.5% of the FTSE Emerging Index and invest into the China A-share market via and mid-cap securities to be added in 0.57% of the FTSE Global All Cap Index. three market access mechanisms: QFII, 2020. R-QFII and Stock Connect. As a result, As two of the main benchmark index interest in the domestic China equity According to MSCI data, Chinese providers for the industry, these market has been growing. equities could eventually comprise developments mark an inflection point more than 40% of the MSCI Emerging for Chinese equities. Although full In 2018, after a multi-year consultation Markets Index, with more than 13% A-share inclusion is unlikely to happen period and a year-long planning interval, weighted in China A-shares. For the quickly, the next five years should MSCI added approximately 230 China MSCI China Index, the domestic equity see a steady progression towards full A-shares to the MSCI Emerging Markets component could increase to a third. representation. Index over a two-phase process in May and August. FTSE Russell, another major index As index weightings change to better provider, said that it would add China reflect the relative size of the China While the initial allocation was small – A-shares to its indices in three tranches equity market in terms of market just 0.8% of the MSCI Emerging Markets starting from June 2019 and ending capitalisation and trading volumes, Index and 2.3% of the MSCI China Index in March 2020. Inclusion would be Chinese equities could eventually based on a 5% partial inclusion factor based on 25% of the investable market qualify as a standalone asset class. (PIF) – it represented an important capitalisation of eligible securities, What might happen in the next five years?

MSCI China 2.3% 0.2% 8.6% 0.1% 0.2% 17.5% 25.1% 23.5% 32.0% 30.8% 8.8% 5% 20% 28.8% 100% Inclusion Inclusion Inclusion 12.6% 11.8% 20.2% 21.4% 29.0% 27.1%

China A 2.3% China A 8.6% China A 32.0% China B 0.2% China B 0.2% China B 0.1% China H 30.8% China H 28.8% China H 21.4% China P 29.0% China 27.1% China P Chip 20.2% China 12.6% China RED Chip 11.8% China RED Chip 8.8% Overseas ADR 25.1% Overseas ADR 23.5% Overseas ADR 17.5% Source: MSCI, First State Stewart Asia, as of 1st June 2018. Forecasted weights for 20% and 100% inclusion have been extrapolated from MSCI data. 3 Tapping into a broader range of investment opportunities as China market opens up | November 2018

The broadening opportunity choose from. Chinese companies have to-earnings (P/E). In the offshore delivered strong earnings growth in market, the is trading set comparison to major global markets in at around 10.1x forward P/E with The total China equity market, the US, Europe, Japan and across the estimated earnings growth of 10.0%, including both onshore and offshore Asia Pacific. while the Hang Seng China Enterprises Index is trading at 9.0x P/E with a equities, contains plenty of high quality Consensus 12-month earnings growth growth outlook of 10.8%. franchises and growth opportunities estimates2 for the Shanghai Composite for bottom-up stock selectors to is 13.4% at a valuation of 11.9x price- China has delivered strong historical earnings growth EPS CAGR 2008-2017 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Shanghai Shenzhen Korea US Asia Pacific Japan Taiwan India Emerging Europe Composite Composite ex Japan Markets

Source: Bloomberg, First State Stewart Asia. Trailing weighted EPS growth as at 31 December 2017

A-share aggregate earnings (RMB bn) 3,500 3,000 2,500 2,000 1,500 1,000 500 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: FactSet

Onshore vs. offshore more representative of the underlying Within A-shares, there are also Chinese economy. differences between the two main As investor portfolios might already domestic exchanges. Due to historical For example, home furnishing retailers, include offshore Chinese equities, how reasons (proximity to the seat of housewares and general merchandise would the inclusion of A-shares affect government in Beijing, as well as being stores are exclusive to the A-share the asset allocation? Although there is the hub for merchant trading since the market, while others, such as food some overlap – some companies are late 1800s), state-owned enterprises distributors and diversified real estate dual-listed with both an A-share and (SOEs), large-caps and ‘old economy’ investment trusts (REITs) are part of the an H-share class – the broad-based industries such as consumer companies, offshore H-share market, but are not in A-share market covers a wider range of financials and manufacturers form industry sectors and is considered to be A-shares.

2 Source: UBS Securities, Go-goal, IBES, as at November 2018 4 Tapping into a broader range of investment opportunities as China market opens up | November 2018

the majority of the Shanghai Stock Exchange. Meanwhile, the Shenzhen Stock Sectors in A shares, Sectors in H shares, Exchange, which includes the Main not in H shares not in A shares Board, the SME3 Board and the ChiNext Homebuilding Board, contains smaller to medium- Homefurnishing Retail sized companies; and includes a Housewares & Specialities greater number of ‘new economy’ and Soft Drinks Casinos & Gaming technology stocks. General Merchandise stores Drug Retail Food Distributors The ChiNext Board, in particular, is Broadcast ting Diversified REITs similar to the NASDAQ in the United Oil & gas Refinery & Marketing Diversified Capital Markets States (or the AIM market in the United Distillers &Vintners Property & Casualty Precious Metals and Minerals Insurance Kingdom) and allows fledgling growth Reinsurance companies to raise equity capital with Industrial Gases Cable and Satellite Silver more flexible listing requirements than Research and Consulting Multi-Sector Holdings the Main Board. Services In the offshore market, H-shares are Human Resources Services dominated by financials, mainly due to Commercial Printing Office Services & Supplies the major Chinese banks and financial Technology Distributors institutions which chose to list in Hong Kong to raise capital outside of China. Red chips are skewed towards the energy and telecoms sectors, while P Chips and N-shares are predominantly focused on technology and consumer Note: Green colour indicates New China sectors companies. Source: Wind, FactSet, Goldman Sachs Global Investment Research

China Indices - sector differences

MSCI CHINA

HSCEI

H S I

CHINEXT

SCOMP

SHCOMP

0 20 40 60 80 100 Consumer Discretionary Health Care Real Estate Consumer Staples Industrials Telecom Services Energy Information Technology Utilities Financials Materials

Source: Bloomberg, FactSet, First State Stewart Asia, as at 31 October 2018.

3 Small and Medium Enterprises 5 Tapping into a broader range of investment opportunities as China market opens up | November 2018

Index concentration However, more recent performance Financials still comprise the second- of the technology sector has boosted largest segment of the index and A closer look at the MSCI China index its relative weight in the index. together, almost 60% of the index is and how it has evolved over the past Technology has now overtaken weighted to just these two sectors. 10 years highlight a few interesting financials; and around a third of the We believe this reflects an unwelcome observations. Historically, financials MSCI China is now comprised of just concentration of risk – and not and energy companies were the three large tech companies: , truly reflective of the investment largest constituents of the index. Alibaba and Baidu. opportunities available to the unconstrained investor. 10-year evolution of the MSCI China

100 90 80 MSCI 70 China 60 index 50 (bps) 40 30 20 10 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Consumer Discretionary Health Care Real Estate Consumer Staples Industrials Telecom Services Energy Information Technology Utilities Financials Source: FactSet, First State Stewart Asia, as at 31 October for each corresponding year.

MSCI China Index Top 10 weights over time

2009 Sector Weight (%) 2018 Sector Weight (%) Telecom Information Limited Services 10.5 Tencent Holdings Technology 13.66 Information Corporation Class H Financials 7.2 Alibaba Group Holding Ltd Technology 11.57 Industrial and Commercial China Construction Bank Limited Class H Financials 6.8 Corporation Class H Financials 5.37 China Life Insurance Co. Ltd. Telecom Class H Financials 6.4 China Mobile Limited Services 4.04 Bank of China Limited Class H Financials 6.2 Information Baidu, Inc. Technology 3.70 CNOOC Limited Energy 5.1 (Group) Company of China, Ltd. Class H Financials 3.45 PetroChina Company Limited Class H Energy 4.8 Industrial and Commercial Bank of China Limited Class H Financials 3.30 Tencent Holdings Ltd. Information 2.9 Technology Bank of China Limited Class H Financials 2.38 Co. Ltd. Class H Energy 2.7 CNOOC Limited Energy 2.16 China Petroleum & Chemical China Petroleum & Chemical Corporation Class H Energy 2.5 Corporation Class H Energy 1.46

Source: FactSet, First State Stewart Asia, as at 31 October 2018. Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same.

6 Tapping into a broader range of investment opportunities as China market opens up | November 2018

A few considerations To combat this, general stock prices are trading designed to support stock subject to daily up/down trading limits prices. National service can also be The China A-share market is still of +/- 10%, which restrict an investor’s called upon to lift market sentiment relatively young and, like the overall ability to buy or sell securities during ahead of important dates in the Chinese economy, remains heavily volatile periods. If a company’s share political diary. influenced and directed by the price hits the price limit (either up or These interventions distort the price government. This has led to some down), trading is automatically halted discovery mechanism and lead to an market idiosyncrasies that investors until the following day. should be aware of. inefficient market over the shorter Companies can also voluntarily suspend term. However, this presents an Firstly, market participants are mostly trading of their shares, in an attempt attractive opportunity for active retail investors, often trading on margin to ride out market volatility and avoid investors to generate alpha – by accounts which provide financing to investor selling. During the stock market investing over a longer-term time leverage an investor’s stock market rout in mid-2015, more than half of all horizon, using a fundamentally-driven exposure. Around 80% of the market listed A-share companies suspended investment approach and employing (by trading volume) is comprised of trading in an attempt to stem outflows. robust valuation models to identify small retail investors and day traders mispriced stocks. who tend to be more speculative and During these periods of market have a shorter-term mind-set. This is volatility, state-owned banks and one of the key reasons for the A-share brokers are often conscripted into market’s heightened volatility. ‘national service’, with state-mandated

First State China Fund Range China Growth China Focus China A Share All China Inception date May 1992 January 2008 October 2009 March 2017

Portfolio manager Martin Lau Quanqiang Xian Quanqiang Xian Winston Ke MSCI China All Benchmark MSCI China MSCI China MSCI China A Shares Number of holdings 40-70 20-40 10-50 20-50 USD1.5 billion free Minimum market cap Nil float Nil Nil Typical A-share allocation 20% 15% 70-80% 40%

Fund structure Dublin VCC Dublin VCC Dublin QIAIF UK OEIC

First State China Fund Range 100 90 80 70 60 50 40 30 20 10 0 China Growth China Focus China A All China

China A Shares Hong Kong Taiwan China B Shares P Chip US Listed China H Shares Red Chips Cash

Source: First State Investments, as at 31 October 2018

7 Tapping into a broader range of investment opportunities as China market opens up | November 2018

About the team to identify high quality companies to Investment approach invest in for the long term. We look for First State Stewart Asia is an founders and management teams that In summary, our investment approach autonomous investment management act with integrity and risk awareness; is based on: team within First State Investments, and dominant franchises that have - Bottom-up stock selection with offices in Hong Kong, Singapore the ability to deliver sustainable and and Edinburgh. The team manages predictable returns over the long term. - Quality companies US$23 billion (as at 30 September 2018) across a range of Asia Pacific We are conservative investors and - Strong valuation disciplines and Global Emerging Market equity define risk in terms of the permanent - Long-term investing strategies on behalf of clients globally. loss of capital, rather than deviation from any benchmark index. We believe - Absolute return mindset We are conviction-based, bottom-up that by investing in quality companies - Benchmark indifference stock selectors with a strong emphasis and holding for the long term, the risk on proprietary research. Our goal is to capital is greatly reduced.

Important Information The information contained within this document has been obtained from sources that First State Investments (“FSI”) believes to be reliable and accurate at the time of issue but no representation or warranty, expressed or implied, is made as to the fairness, accuracy, completeness or correctness of the information. Neither FSI, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from any use of this. This document is intended solely for distribution to professional/institutional investors as may be defined in the relevant jurisdiction and is not intended for distribution to the public. The information herein is for information purposes only; it does not constitute investment advice and/or recommendation, and should not be used as the basis of any investment decision. Some of the funds mentioned herein are not authorised for offer/sale to the public in certain jurisdiction. Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of First State Investments’ portfolios at a certain point in time, and the holdings may change over time. The value of investments and the income from them may go down as well as up and you may not get back your original investment. Past performance is not necessarily a guide to future performance. Please refer to the offering documents for details, including the risk factors. This document/the information may not be reproduced in whole or in part without the prior consent of FSI. This document shall only be used and/or received in accordance with the applicable laws in the relevant jurisdiction. In Hong Kong, this document is issued by First State Investments (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. In Singapore, this document is issued by First State Investments (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. First State Investments and First State Stewart Asia are names of First State Investments (Hong Kong) Limited. First State Investments (registration number 53236800B) and First State Stewart Asia (registration number 53314080C) are business divisions of First State Investments (Singapore). First State Investments (Hong Kong) Limited is exempt from the need to hold an Australian financial services licence under the Australian Corporations Act (Cth) 2001. It is regulated by the Securities and Futures Commission of Hong Kong under Hong Kong laws, which are different to Australian laws. First State China Growth fund, First State China Focus fund and First State China A Share fund are restricted foreign schemes in Singapore and are not available to persons in Singapore other than (i) to an institutional investor under Section 304 of the Securities and Future Act (SFA), (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305 of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. First State All China Fund has not been registered with the Monetary Authority of Singapore. Accordingly, this fund and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of Units may not be circulated or distributed, nor may Units be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. Commonwealth Bank of Australia (the “Bank”) and its subsidiaries are not responsible for any statement or information contained in this document. Neither the Bank nor any of its subsidiaries guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of the Bank or its subsidiaries, and are subject to investment risk, including loss of income and capital invested. MAR00339_1118_EUUK M-SG-2018/38

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