FINDING CLARITY

FOREWORDAUSTRALIA 2016

Four global themes driving investments

A CLOSER LOOK AT CHINA, FROM AN INVESTOR’S VIEWPOINT Robert Mann, Nikko AM Senior Portfolio Manager, Asian Equity

CURRENT ECONOMIC CONDITIONS

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IMF estimates of Chinese growth

38 Source : Merrill Lynch, IMF, June 2016

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Short-term view

39

Any prediction, projection or forecast on the economy or the economic trends of the markets is not necessarily indicative of the future or likely performance Source : Nikko AM Asia, as at 22 June 2016

• Growth to remain roughly stable this year and next (6% to 6.5%) • Authorities want stable growth going into next year’s Congress • The GOOD:

– Consumption is growing strongly – Services sector is growing strongly

• The BAD: – Heavy industry is weak – Infrastructure investment has surged – Debt levels are high but with flush liquidity, crisis in short term is unlikely

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Long-term view

40

Any prediction, projection or forecast on the economy or the economic trends of the markets is not necessarily indicative of the future or likely performance Source : Nikko AM Asia, as at 22 June 2016

China is undergoing economic transformation • Success needs:

– Authorities with power to reform – Knowledge of necessary reforms – Prepared to use that power

• Major long-term reforms of SOEs are vital • 2017 Party Congress is critical

Markets • A shares were a bubble and now part deflated • H shares look outright cheap • Call on reform will be crucial in next 2 years

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Political debate

41 Source : Nikko AM Asia, as at 22 June 2016

Xi frustrated by lack of reform “A People’s Daily article published yesterday showed that China’s leadership is trying to make a grand shift in the nation’s economic policies in a bid to say goodbye to debt fuelled growth. In a sign of distaste for the credit-pumped growth in the past couple of months, the Communist Party mouthpiece cited an unidentified “authoritative” figure as saying that boosting growth by increasing leverage was like “growing a tree in the air” and that a high leverage ratio could lead to a financial crisis. Economic growth was set to enter a so-called L-shaped trajectory for a few years and it was unrealistic to expect any rebound in the world’s second largest economy, according to the article”. South China Morning Post 9 May 2016 Balancing 3 policy areas • Political reform (anti corruption) • Economic reforms, and the • 6.5% growth floor (National People’s Congress, Mar 2016)

Debate about going for growth now and let growth fix the issues vs. need to enact reform now − Xi appears in latter camp

SOE and FX reform will both lag

THE GOOD

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China has most middle class adults

43

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Strong growth in affluent households

44 Source : Gavekal Data/Macrobond, June 2016

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Tourism to Australia

45 As at June 2016

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Economy is changing

46 As at June 2016

Chinese Imports Movie Ticket Sales

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Sportswear sales

47 As at August 2016

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Education seen as essential

48 As at August 2016

THE BAD

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SOE reform is vital

50 Source : Gavekal Data/Macrobond, May 2016

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Too much credit to SOEs

51 As at July 2016

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How much of a problem is debt?

52 Source: Gavekal Dragonomics, May 2016

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Residential investment: the source of the imbalance

53

As at March 2016 As at April 2015

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Implications

54

Any prediction, projection or forecast on the economy or the economic trends of the markets is not necessarily indicative of the future or likely performance Source : Nikko AM Asia, as at 22 June 2016

• China can avoid a recession, but time is running out

• Rebalancing means slower growth, even slower imports, and is much less commodity intensive

• Expect over-capacity in new industries

• China’s middle class growth is a major development – Tourism and education are big beneficiaries – Most of the gains will accrue to Chinese companies

• In a growth-starved world, China continues to grow

MARKET IMPLICATIONS

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Where will China’s savings go?

56

Any prediction, projection or forecast on the economy or the economic trends of the markets is not necessarily indicative of the future or likely performance Source : Nikko AM Asia, as at 22 June 2016

• Investors should anticipate China’s savings flows

• China’s savings will be more important for global markets – Stage 1 was buying Treasuries and iron ore mines – Stage 2 is technology and housing in selected global cities – Stage 3??

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CFETS RMB index

57 Source : China Foreign Exchange Trade System (CFETS) as at 19 August 2016

RMB Historical Index

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Current market developments –China phenomenon

58 Source : Bloomberg as at 24 August 2016

MSCI China versus CSI 300 Index

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Asia or emerging markets?

59 Source : Factset as at 21 June 2016

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How to invest for next stage of China’s growth

60 Source : Barra, Factset as at 22 June 2016

• China will eventually dominate MSCI EM Index, and already has major impact – Asia now over 70% of MSCI EM Index – China 27% of MSCI EM Index – China 2nd-largest economy yet only 2.7% of All Country World Index (ACWI) – Once A shares enter indices, China will dominate

• How to get exposure?

Pros Cons

Global Do asset allocation into China Limited expertise

EM Asset allocation between Asia and other EMs, understand EM flows

Non-Asia is very resource heavy, expertise historically tends to be more non-Asia

Asia Asset allocation between China and Asia, must understand China

How to get non-Asia EM exposure

China China expertise Too close to China, how to decide weighting

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Important information

This material was prepared and is presented by Nikko AM Limited ABN 99 003 376 252, AFSL 237563 (Nikko AM Australia). Nikko AM Australia is part of the Nikko AM Group. It is for the use of researchers, licensed financial advisers and their authorised representatives. This material has been prepared without taking into account a potential investor’s objectives, financial situation or needs, and is not intended to constitute personal advice, and must not be relied upon as such. Past performance is not an indicator of future performance. Any economic or market forecasts are not guaranteed. Whilst we believe the information contained in this material to be correct as at the date of presentation, no warranty of accuracy or reliability is given and no responsibility is accepted for errors or omissions. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided as to the positions.