2016/17 China Macroeconomic Outlook & Market Opportunities

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CHINA ASSET MANAGEMENT
2016/17 China Macroeconomic Outlook & Market Opportunities
House View
October 2016
Confidential
This document is for professional clients and qualified/institutional investors only
It is not to be distributed to or relied upon by retail clients

China Asset Management House View, October 2016
2 This document is for professional clients and qualified/institutional investors only. It is not to be distributed to or relied upon by retail investors.
CONTENTS
1. Review of China Macroeconomic Environment in 2016
1.1 Over-leverage: High Leverage Levels Compel Deleveraging 3
1.2 Financial Reform Deepens, More Efforts Down the Road 7
1.3 Chinese Credit Issue: More Frequent Defaults, Systemic Risk Unlikely 9
1.4 Supply Side Reform: Capacity Reduction May Intensify in 2016H2 10
1.5 Property Markets: Impending Risks after Rampant Growth 13
2. China Macroeconomics in 2017
2.1 Support and Potential Issues of the Chinese Economy 18
2.2 Potential Effects of the Fed’s Rate Hike on the Chinese Economy 22
3. Investment Strategies in 2017
3.1 Equity Market Opportunities 25
3.1.1 Recap of Chinese Equity Markets in 2016 25
3.1.2 Equity Investment Opportunities in 2017 27
3.2 Fixed Income Opportunities 29
3.2.1 RMB’s Inclusion into the SDR Basket 29
3.2.2 Fixed Income Investment Opportunities in 2017 32

This document is for professional clients and qualified/institutional investors only. It is not to be distributed to or relied upon by retail investors. 3
1. Review of China Macroeconomic Environment in 2016
1.1 Over-leverage: High Leverage Levels Compel Deleveraging
Bank of International Settlements (“BIS”) estimated that non-financial institutions (government,
corporations, and households) in China had a total leverage ratio of 248.6% as of September 2015. This
exceeds that of developing countries such as Brazil, India, and Russia, and is among the highly levered
developed economies. The Chinese leverage ratio is only lower than Japan (387.1%), France (291.3%),
and United Kingdom (262.6%).
Exhibit 1. Non Financial Corporate Leverage Ratio across Major Economies (%)
Source: BIS, value of debt calculated at market value
Leverage levels of Chinese non-financial institutions were estimated by BIS, while the total leverage
was estimated by China Academy of Social Sciences (“CASS”). Although exact figures differ, the overall
trend is consistent. After a short halt in 2010 and 2011, the Debt/GDP ratio of various Chinese economic
components had steadily risen since 2008.
Exhibit 2. China Leverage Ratio Hit New Highs since 2008 (%)
Source: Wind
0
50
100
150
200
250
300
350
400
Japan France UK China US Germaney Brazil India Russia
Household Debt/GDP Non Financial Corp Debt/GDP Govn't Debt/GDP
0
20
40
60
80
100
120
140
1997
1998
1999
1999
2000
2000
2001
2002
2002
2003
2003
2004
2004
2005
2006
2006
2007
2007
2008
2009
2009
2010
2010
2011
2011
2012
2013
2013
2014
2014
2015
Household Debt/GDP Govn't Debt (Central+Local)/GDP
Financial Institution Debt (Bonds)/GDP Non Finaical Corp Debt (incld SOEs)/GDP
Record leverage
levels throughout the
economy
Chinese economy
among other highly
levered economies

S
We estimate the Chinese economic leverage ratio to be approximately 248.5% at the end of 2015,
among which 127.8% was attributed to the corporate sector. Bank loans, non-standardized loans and
bond financing are the main sources of corporate liabilities.
Exhibit 3. Leverage Composition of the Corporate Sector
Source: Wind
As the main source of corporate liabilities, the bank loan ratio has been traditionally stable at around
80% for the past three years. Since 2013, credit growth dropped to below 10% in 2015. By August 2016,
corporate credit growth had dropped to 8.6%, approaching the levels of nominal GDP growth.
Alternatively, non-standardized loans and bond financing both rebounded in 2016H1, with
year-over-year growth at around 20%. Hence corporate sector leverage, defined as the combination of
these sources had no meaningful decline.
Exhibit 4. Bank Loan Growth vs. Non-Standardized + Bond Financing (%)
Source: Wind
Microeconomic data indicates that the aggregated debt ratio of the industrial sector has trended
downward, yet the debt ratio of State-Owned-Enterprises (“SOE”) picked up despite its previously high
levels. Prioritizing expansion over profitability, SOEs have been the pillar in growth stabilization and
credit expansion.
70
75
80
85
90
95
100
105
-40
-20
0
20
40
60
80
100
120
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Bank Loan/GDP (Non-Standardized+Bonds)/GDP
Infrastructure Finance/GDP (Debit) Bank Loan % (Right)
0
20
40
60
80
100
120
140
0
5
10
15
20
25
30
35
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Bank Loan Growth
Non-Standardized+Bond Growth (Right)
Industrials levered
down, Chinese SOE
levered up
Credit growth
subsides, bond
financing bottomed
Leverage in corporate
sector remains high

Exhibit 5. Monthly Total Borrowing by Trust Loans, Entrusted Loans and Corporate Bonds
Source: Wind
Exhibit 6. Leverage Ratio: Industrial Sector Down, SOEs Up
Source: Wind
By the end of 2015, China Government Bonds (“CGB”) outstanding totaled to 10.7 trillion RMB. This
represents approximately 80% of the central government’s total obligations and implies approximately
13 trillion RMB in total debt owed by the central government. In the same period, total debt obligation
borne by the local government totaled 16 trillion RMB, plus an estimated contingent obligation of 10
trillion RMB. These figures imply a total public sector leverage of 57.2%, up 2% from 2014, with central
government and local governments account for 19% and 38% respectively.
Exhibit 7. Leverage Ratios of Central and Local Governments
Source: Wind
0
200
400
600
800
1,000
1,200
01 02 03 04 05 06 07 08 09 10 11 12
2013 2014 2015 2016
63.0
63.5
64.0
64.5
65.0
65.5
66.0
66.5
67.0
56.0
56.5
57.0
57.5
58.0
58.5
59.0
59.5
60.0
12-2 12-8 13-2 13-8 14-2 14-8 15-2 15-8 16-2
Industrial Corp Debt% SOE Debt% (RHS)
0%
10%
20%
30%
40%
50%
60%
09 10 11 12 13 14 15
Central Government Leverage Local Government Leverage
Public sector
leverage: central
government lever up,
local governments
deleverage

Exhibit 8. Major Government Debt as % of GDP
Source: Bloomberg
The current leverage level of the Chinese central government is well below the red line of 60%. While its
global counterparts such as the US, Japan and EU are all well above 50% (but their local government
debt levels are lower than China), which leads to the conclusion that the Chinese central government
debt level may be well managed. Yet, high local government debt remains a potential concern. The
Chinese government introduced No.43 legislation, which focuses on quota rationing of the local
government debt and local government debt swaps.
Local government debt is mainly comprised of local government bonds, external sovereign debts,
financing platform loans, trust loans and local-government funding vehicle (“LGFV”) bonds. After the
2015 local debt swap, financing platform loans account for 44% of total local government debt, LGFV
bonds and trust loans accounted for another 35%, local government bonds (general + swap) account for
the remaining 20% and is expected to grow.
In order to counter deleveraging in the corporate sector and as the accompanying effects of a sliding
economy, the government remains the key driving force in adding leverage. In China, the most likely
path is for the central government to lever up and the local government to deleverage. Central
government still has ability and flexibility to add debt, expand government deficit and increase CGB
issuance to finance fiscal spending. At the local level, swaps of the existing debt remains a priority. New
debt issuance will be tightly scrutinized by budget controls to prevent risks.
Exhibit 9. Fiscal Income
Source: Wind
0%
50%
100%
150%
200%
250%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Japan Germany U.S U.K. Eurozone
-2,000
-1,500
-1,000
-500
0
500
1,000
1,500
2,000
2,500
3,000
13-7 13-10 14-1 14-4 14-7 14-10 15-1 15-4 15-7 15-10 16-1 16-4 16-7
Net fiscal income Fiscal revenue Fiscal expenditure
With the public sector
levering up, and the
fiscal spending
outpacing fiscal
income, deficit ratio
could surpass 3%

The household indebtedness has been climbing since 2008, and has reached 40% by the end of 2015.
Globally, such debt level not only falls behind developed economies such as U.S., Japan and the EU,
but also lags those of Brazil, India and Russia. From a structural point of view, medium to long term
consumer loans account for the largest portion of household debt, rising from its low of 52.0% in 2013 to
54.9% in 2015.
The medium to long term loan growth has exceeded 30% in 2016, and 20% for the household loan
growth. Based on these growth figures, household leverage could reach 45% in 2016. If we take the
provident loans into account, the de-facto household leverage could be as high as 50%. Owing to the
heterogeneity in GDP composition, Chinese household disposable income as a percentage of GDP is
significantly lower than that of developed nations. Hence, Chinese household leverage could be in
reality, comparable to those of U.S. and Japan. Global experience suggests that, as dependency ratio
bottoms, household leverage typically peaks. The Chinese dependency ratio bottomed in 2011, implying
limited room for further leverage stretching by the household sector.
Exhibit 10. Growth of Household Leverage
Source: Wind
Exhibit 11. Household Leverage of Major Economies Moderated after Reaching Peaks
Source: Wind
1.2 Financial Reform Deepens, More Efforts Down the Road
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0
5
10
15
20
25
30
35
04 05 06 07 08 09 10 11 12 13 14 15 16E
Trillion RMB
Long-term business loans Long-term consumer loans
Short-term business loans Short-term consumer loans
Household debt ratio (see right)
0%
10%
20%
30%
40%
50%
60%
70%
80%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
70 75 80 85 90 95 00 05 10 15
UK US
Japan (right) Germany (right)
Household leverage
growth accelerated
Household sector
leverage: low
baseline, rapid growth

In the Government Working Report issued in March 2016, detailed working plans were announced to
materialize further financial system reforms. Key focus areas include refining financial regulation and
oversight, deepening interest rate and RMB exchange rate market reform, and accelerate of capital
market reform and legislation. Specifically, the following milestones have been achieve within the 2016:
The Value-Added Tax reform, which was kick-started in Jan 1, 2012, is now at full speed. Since May 1st
,
2016, last four industries: Construction, Real Estate, Financials, and Services will be admitted into the
pilot scope to further reduce corporate tax burden and promote professional specialization.
The People’s Bank of China (“PBOC”) has dedicated a special column in its May 6, 2015 issue of
“2016Q1 monetary policy enforcement report”, detailing the market-driven CNY/USD fixing formation
mechanism. It has concluded that the “Closing rate + exchange rate change of a basket of currencies”
CNY/USD fixing formation mechanism has been established.
On May 11, 2016, China Insurance Regulatory Commission (CIRC) and the Ministry of Finance jointly
announced the “Implementation Plan for Establishing the Catastrophe Insurance System for Urban and
Rural Residential Housing in Earthquakes”. This marked a milestone of the Chinese catastrophe
insurance system.
The centerpiece of the reform is a reform and innovation framework featuring bilateral free trade
accounts, RMB cross-border transactions, interest liberalization and foreign exchange reform which
aims to promote Shanghai as a global financial hub. The opinion issued by the Shanghai government
also outlines risk prevention guidelines associated with the internationalization of the RMB.
It is expected to go online after a four month trial run. At the same time, the aggregated quota has been
abolished for both SH and SZ connects, which marks another milestone in improving market
accessibility. As a result, 70% of the market capitalization, both northbound and southbound becomes
directly accessible.
Table 1. Other Financial Reforms
Financial Oversight
Financial regulators will continue to push for reform to maintain market order
and risk oversight. Details pending
Other Financial
Reforms
Mentioned in the
Government
Working Report of
2016
Deepening interest market reform
Extend state-owned commercial banking and government financial
institutional reform, develop private-owned banking sector. Begin trials for
alternative lending and investment programs.
Further equity and debt market reform and the development of the
legislative landscape. Improve proportion of direct investments.
Standardize and develop online banking and finance platforms. Promote
financial inclusiveness and green finance. Crack down on financial crimes
including illegal collection of funds. Aim to prevent systemic crisis.
HK-SZ Connect
officially announced
in August
Reform accelerated in
Shanghai Free Trade
Zone
Catastrophe
insurance system
underway
CNY fixing formation
mechanism in place
VAT pilot program at
full speed

1.3 Chinese Credit Issue: More Frequent Defaults, Systemic Risk Unlikely
Since 2016, there have been 24 defaults across major bond types (commercial papers, super
short-term commercial papers, medium-term notes, enterprise bonds, corporate bonds, and private
placement notes), doubled that of 2015. Default entities include private companies, SOEs, and
companies owned by regional governments. Only Local Government Funding Vehicles (“LGFV”) debt
remains intact.
Defaulting issuers in 2016 concentrated into three categories: over-capacity SOEs in heavy industries
such as steel, coal, and cement; renewable energy industries such as solar and wind power; and
private-owned light manufacturing firms and consumer firms. Corporate governance issues were
common among the default entities.
Among the 18 companies that defaulted on their obligations, no bond types were immune from the
credit risk outbreak, including Short Term Commercial Papers (SCPs). Rating wise, AA issuers
accounted for 65% of the defaults, and AA+ and AA- account for 18%. None of the AAA rated issuers
report defaults. There is no precedent of an AAA issuer defaulting.
Exhibit 12. Number of Bond Defaults by Sector
Source: Wind
Catalysts to Credit Risks
1) Internally, against the backdrop of macro economy slide and overcapacity issues, corporate
earnings deterioration and operating cash flow decline pushed up demand for external financing.
Burdened by more indebtedness, the repayment ability further weakens.
2) Externally, the de-capacity effort made refinancing and rolling over of borrowing more challenging.
Bond investor taking refuge in safety has led to widening credit spread and even cases of
unsuccessful credit bond issuance.
3) Creditor protection scheme to be further improved and instruments for credit risks hedging are
currently absent.
0
1
2
3
Newenergy
Mining
Steel
Food&beverage
Lightmanufacturing
Cement
Non-ferrousmetals
Food&Catering
Chemicals
Machinery
Commerce
More credit defaults,
LGFVs remain intact

Defaults unlikely to trigger systemic risks
1) Total value of defaults is still minimal, merely 0.2% of total credit bond value outstanding, and
0.02% of total social financing outstanding.
2) The less risky bond classes, such as LGFV bonds, utilities, account for roughly 46%, overcapacity
industries account for 15%. Among over capacity issues, 78% are AAA rated bonds and less than
10% are rated AA or below.
Exhibit 13. Term Bonds Market by Issuer Type
Source: Wind
Exhibit 14. Credit Rating of Outstanding Bonds in Overcapacity Industries
Source: Wind
1.4 Supply Side Reform: Capacity Reduction May Intensify in 2016H2
With output rising instead of falling, the steel industry still faces weak supply-demand dynamics and
headwinds are expected with the capacity reduction progress. By July 2016, only 47% of the annual
target was met. The de-capacity progress varied by region. Regional shares of production capacities
have shifted. The steel industry has decelerated its capacity growth but has yet to reduce actual
capacity.
Urban Construction,
Infrastructure & Utilities
46%
Coal, Steel & Non-ferrous
metals
15%
Real Estate
6%
Others
33%
AAA
78%
AA+
13%
AA
7%
AA- and lower
2%
Steel industry faces
headwinds
Defaults unlikely to
trigger systemic risks

Exhibit 15. Weekly Steel Inventory YoY Growth (%)
Source: Wind
By July 2016, the coal industry has reduced its production capacity by approximately 95 million tons, or
38% the annual target of 250 million tons. 2016 progress varied by province. Some provinces have
already reached their targets, while others, such as Inner Mongolia, Fujian, Ningxia, Guangxi, and
Xinjiang have just initiated their de-capacity program. August saw significant acceleration progress. By
the end of August, national-wide capacity has reduced by 150 million tons, or 60% of the annual target.
Current supply-demand structure favors coal over steel. Since June 2016, coal demand has recovered
due to higher consumption growth in power generation. Inventory levels at key power plants and ports
have declined declines. Between January and July 2016, output capacity has been cut by 10%, and
capacity reduction is expected to continue.
Exhibit 16. Coal Consumption YoY Growth by Major Power Companies
Source: Wind
-20%
-10%
0%
10%
20%
30%
40%
50%
W1 W6 W11 W16 W21 W26 W31 W36 W41 W46 W51
2011 2012 2013 2014 2015 2016
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
13-8 14-2 14-8 15-2 15-8 16-2 16-8
Coal Consumption by Six Major Power Companies Daily Average YoY Growth
Coal Consumption by Six Major Power Companies Monthly Average YoY Growth
Sound supply-demand
dynamics in coal
industry while
de-capacity continues

Exhibit 17. Coal Inventory Levels in Key Power Plants
Source: Wind
Growth rate of the nationwide property for sale by square footage trended downwards since 2015.
Growth of residential square footage for sale decelerated from 30% in 2014 to nearly 0% in 2016.
Exhibit 18. Square Footage of Residential Properties for Sale YoY Growth
Source: Wind
Cost component as a percent of revenue has consistently decreased over the past two years. Between
March and July 2016, profit margin in the industrials sector reached new highs over the same period
since 2012.
Exhibit 19. Profit Margin of the Industrial Sector
Source: Wind
10.00
15.00
20.00
25.00
30.00
35.00
40
60
80
100
14-8 15-2 15-8 16-2 16-8
Spot Inventory (Million Tons) Turnover days
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
01-7 02-7 03-7 04-7 05-7 06-7 07-7 08-7 09-7 10-7 11-7 12-7 13-7 14-7 15-7
Square Footage of Properties for Sale YoY Growth
Square Footage of Residential Properties for Sale YoY Growth
4.5%
5.0%
5.5%
6.0%
6.5%
1-2 3 4 5 6 7 8 9 10 11 12
2011 2012 2013 2014 2015 2016
Cost reduction
initiatives shown early
results in the
industrials sector
Accelerated inventory
reduction in the
property market

1.5 Property Markets: Impending Risks after Rampant Growth
By August 2016, residential property square footage sold grew by 25.8%, sales soared by 40.1%.
Property prices in first tier cities boomed and spill-over effects were observed in second tier cities.
According to the National Bureau of Statistics, resold property price in Shenzhen, Beijing and Shanghai
rallied by 66%, 48% and 39%, respectively.
Exhibit 20. Residential Property Sales vs. Real Estate Investment YoY (%)
Source: Wind
Exhibit 21. Housing Price Changes among 70 Cities YoY (%)
Source: Wind
Property purchases are backed by mortgages. Data suggests that from 2015 to 2016H1, deposit growth
has been relatively stable. However, loan growth has risen significantly in 2015. The discrepancy was a
result from lower interest rates and the revision in deposit calculation guidelines by PBOC in early 2015.
This recategorized 10 trillion RMB in financial institution deposits to general deposits. Loan-to-deposit
ratio in banks was lowered and fueled a round of rampant credit growth as a result. After June 2015,
PBOC further abolished the loan-to-deposit ratio as a statutory measure, with the intention to support
the real economy with credit.
Exhibit 22. Savings and Lending Growth (%)
Source: Wind
-30
-20
-10
0
10
20
30
40
50
60
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Residential property sales, cumulative growth Real estate development investment amount completed growth
-10
0
10
20
30
13-8 14-2 14-8 15-2 15-8 16-2 16-8
Tier one cities Tier two cities Tier three cities
0%
5%
10%
15%
20%
25%
12-12 13-6 13-12 14-6 14-12 15-6 15-12 16-6
Lending Growth Savings Growth
Property market surge
largely a credit
phenomenon
Chinese property
market surged in price
and volume

Exhibit 23. New Deposits by Year (Billion RMB)
Source: Wind
Households and non-bank financial institutions saw dropping deposit balances. Prior to 2015, the
household deposit decrease was mainly caused by re-allocation to investment products such as the
wealth management products and equities. The tide swiftly turned after the 2015 market correction.
Non-bank financial institution deposits began seeing net outflows after peaking in July 2015. This
indicates that allocation to wealth management products and equities are decelerating.
Households are withdrawing from deposits and allocating to the property market. Household loans grew
by over 20% YoY through July 2016. Medium to long term consumer loans are the key contributor with
over 30% growth and represents approximately 50% of the total loan market. Over 80% of the loans in
this category are mortgages. Growth in other types of loans we suppressed, falling to 7% YoY, even
lagging deposit growth. The mortgage driven household loan rally has funnel deposits and loans to the
corporate sector through the properties market.
Exhibit 24. Household Deposits Growth
Source: Wind
Exhibit 25. Household Leverage Growth Concentrated in Mid-to-Long Term Consumer Loans
Source: Wind
0
5,000
10,000
15,000
20,000
25,000
2011 2012 2013 2014 2015 2016
-10%
0%
10%
20%
30%
40%
2010 2011 2012 2013 2014 2015 2016
Deposits Balance YoY Growth Current Deposits Balance YoY Growth
Other Deposits Balance YoY Growth
0%
10%
20%
30%
40%
2011 2012 2013 2014 2015 2016
Growth in Loans Outstanding Growth in Mid-to-Long Term Consumer Loans Growth in Other Loans
Households taking
more loans, investing
in properties
Property boom
causing changes in
capital flows

The corporate sector saw higher deposits while new loans decelerated. In 2016H1the non-financial
sectors and syndicated credit growth dipped below 10% for the first time. The industrial sector credit
growth fell under 3% indicating weak credit demand by corporations.
Conversely, the deposit balance surged. Deposits of non-financial companies grew by 16%. Capital has
accumulated in corporate accounts but unutilized. Household property buying and government debt
swap are major sources of these funds.
Exhibit 26. Non-Financial Corporate Deposits YoY Growth
Source: Wind
Exhibit 27. Non-Financials Corporate Credit Balance YoY Growth
Source: Wind
Implied risks present in the property market may exceed previous cycles. The Chinese population has
reached an inflection point. Current fundamentals fail to explain the property bull market. Rapid growth
of household leverage is the true driving force.
If mortgage balance (commercial mortgage and provident mortgage) as a percentage of household
disposable income is used to gauge household leverage, the metric grew from low levels before 2012 to
57% in 2015. We expect this metric to reach approximately 70% in 2016, a level similar to that of the
U.S. and Japan. If this pace continues, mortgage balance may surpass the historical high in the U.S.
and reach 100% of household disposable income.
-20%
-10%
0%
10%
20%
30%
40%
14-1 14-5 14-9 15-1 15-5 15-9 16-1 16-5
Non-financial Deposits YoY Growth Non-financial Current Deposits YoY Growth
0%
2%
4%
6%
8%
10%
12%
14%
16%
14-1 14-5 14-9 15-1 15-5 15-9 16-1 16-5
Non-Financial Credit Balance YoY Growth Industrial Credit Outstanding YoY Growth
Property bull market
driven by leverage,
risks looming
Corporate sector
accumulates capital

Exhibit 28. Mortgage Balance/Household Disposable Income and Projection in U.S., Japan, and
China
Source: Wind
We try to estimate the marginal leverage change of household property purchases using new
mortgage/sales ratio (incremental mortgage/ incremental property sales value). We observed that prior
to 2012, the reading was as low as 25% and it had elevated to 39% in 2015. It is estimated to reach
50% in 2016, which is close to the 52% of U.S.’s peak prior to the financial crisis.
Exhibit 29. U.S Residential Mortgage Increase/Property Sales, Pre-Crisis
Source: Wind
Exhibit 30. U.S. Residential Mortgage Increase/Property Sales, After-Crisis
Source: Wind
0%
20%
40%
60%
80%
100%
120%
140%
160%
1980 1985 1990 1995 2000 2005 2010 2015 2020E
U.S.
Japan
China Scenario 1: mortgage growth of 25%
China Scenario 2: mortgage growth of 30%
0%
10%
20%
30%
40%
50%
60%
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
1999 2000 2001 2002 2003 2004 2005 2006 2007
US residential mortgage increase, million USD
US residential property sales, million USD
US residential mortgage increase/property sales (see right)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2010 2011 2012 2013 2014 2015 2016E
Residential mortgage increase(commercial loan+housing provident loan), billion CNY
Residential property sales(new+second hand), billion CNY
Residential mortgage increase/property sales (right)
Household marginal
leverage surged

Even Japan, in the peak of its bubble economy in 1989 never saw its incremental mortgage/GDP ratio
exceeding 3%. While in the U.S., prior to the outbreak of the financial crisis, this ratio peaked in 2005
after reaching 8%. In China, the incremental mortgages (commercial + provident)/GDP ratio was merely
4.9% in 2015, has jumped to 7.7% in 2016H1. This alerting figure is comparable to the U.S. peak,
implying looming risks in the property market.
Exhibit 31. U.S. and Japan Residential Mortgage Increase/GDP
Source: Wind
Exhibit 32. Chinese Residential Mortgage Growth/GDP
Source: Wind
In essence, the 2016 property bull market in China is a leverage driven one, coupled with vast capital
flow moving between sectors. Deceleration of household deposit growth and surging leverage ratio
would soon reach U.S. historical highs. This may indicate significant risks in the property markets.
Further growth in property prices may come at the cost of lower volume.
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
US mortgage increase/GDP Japan mortgage increase/GDP
0%
1%
2%
3%
4%
5%
6%
7%
8%
2010 2011 2012 2013 2014 2015 2016E
China mortgage increase(commercial loan)/GDP
China mortgage increase(commercial loan+housing provident fund loan)/GDP
New mortgages as
larger part of GDP

2. China Macroeconomics in 2017
2.1 Support and Potential Issues of the Chinese Economy
Short-term economic rebound in 2016 was primarily supported by real-estate and infrastructure
construction. The industrials value-added grew 6.3% YoY, higher than the expected 6.2% while reaching
a five-month high. This was confirmed by the rebound of Manufacturing PMI and total electricity
generated in August. Growing demand and profitability brought short-term improvements to industrials
and manufacturing. Capital investments in August grew 8.1% YoY compared to 3.9% YoY growth in
July. Growth rates of the major investment categories were mixed. Manufacture-related investments
were largely flat; real-estate received moderate growth while infrastructure investments grew
significantly due to positive fiscal stimulus.
Exhibit 33. Investments in Three Major Industries, YoY Growth (%)
Source: Wind
Significant growth in infrastructure investments were due to relaxed fiscal policies. Significant
infrastructure investments in 2016H1 were a result of relaxed fiscal policies. In 2016H1, growth of fiscal
expenditures reached 15.1%, while the ratio of fiscal expenditure/fiscal income in the first six months in
has reached 104.3%.
Exhibit 34. Fiscal Expenditure/Income Ratio Continues to Grow Since 2008
Source: Wind
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
14-3 14-6 14-9 14-12 15-4 15-7 15-10 16-1 16-5 16-8
Manufacturing Infrastructure Real estate
-2%
0%
2%
4%
6%
8%
10%0%
20%
40%
60%
80%
100%
120%
2008 2009 2010 2011 2012 2013 2014 2015 2016
Fiscal expenditure/Income in the first half year
Net fiscal income/GDP (Right, inverted)
Short-term economic
rebound mainly
supported by
real-estate and
infrastructure
Short-term economic
rebound mainly
supported by
real-estate and
infrastructure

Exhibit 35. Infrastructure Investment and Fiscal Expenditure, Same Month YoY Growth
Source: Wind
However, there may be limited room for economic support through fiscal expenditures in 2016H2. Fiscal
expenditures ratio in the first eight months has reached 105%, while the Ministry of Finance has stated
that downward economic pressures will persist over the next few months. In 2016, Real GDP is
expected to grow by 6.6%, while nominal GDP is expected to grow by 8.5%. Given the projected annual
fiscal income/expenditures in 2016, there may be pressures to reduce fiscal spending in the remainder
of 2016.
Growth in the real-estate sector will likely moderate. The real-estate sector was a significant contributor
to steady economic growth in 2016. Real-estate sales by square footage in the first eight months of
2016 grew by nearly 30% YoY. However, real-estate sales may be reaching historic highs and is
expected to moderate in the future.
Exhibit 36. Residential Properties Sold by Square Footage
Source: Wind
Exhibit 37. Real Estate Investment Growth (%)
Source: Wind
-10%
0%
10%
20%
30%
40%
13-8 14-3 14-9 15-4 15-10 16-5
Infrastructure investment YoY growth
Fiscal expenditure YoY growth
-20
-10
0
10
20
30
40
50
13-9 14-3 14-10 15-4 15-11 16-5
Residential Properties Sold by Square Footage YoY
Residential Properties Sold by Square Footage MoM
-10
-5
0
5
10
15
20
25
13-9 14-3 14-10 15-4 15-11 16-5
Cumulated YoY growth
YoY growth
Fiscal spending
limited in 2016H2

The age group between 25 and 44 is expected to decrease after reaching its peak of 449 million in
2015. This age group is the demographic driving domestic consumptions. Among which they are major
consumers of durable goods including housing, automobiles and furniture, as well as fast-moving
consumer goods including alcohol and beverages, clothing, and entertainment.
Exhibit 38. Projected Change in Population Demographics between 1990 and 2030 (Thousands)
Source: Wind
Developed economies generally observe weakening demand for housing and automobiles upon
reaching population peaks. Historical figures in Japan and Korea showed that new housing construction
figures rise and fell in tandem with the 25 to 45 age group.
New housing construction in China peaked in 2013 and property sales may peak in 2016. New housing
construction experienced significant growth since the Chinese housing reform in 1998. The figure grew
from less than 2 million units in 1998 to 14 million units in 2013. New housing constructions per
thousand have reached 18.5, surpassing that of the U.S. and approaching historical highs of Japan and
Korea. Similarly, property sales may reach a peak of approximately 14 million units in 2016.
Exhibit 39. New Housing Starts per Thousand People
Source: Wind
Exhibit 40. Number of Housing Starts and Sales Volume
Source: Wind
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
<25 25-44 45-64 >65
1990 1995 2000 2005 2010 2015 2020 2025 2030
0
5
10
15
20
25
U.S. Japan S. Korea China
New Housing Starts Per Thousand (Urban) New Housing Starts Per Thousand (Total)
0
5
10
15
07 08 09 10 11 12 13 14 15 16
New Housing Starts Property Sales
Property sales may
peak in 2016
Population inflection
point observed

The current growth cycle in housing price began in 2015. The growth was primarily led by first-tier cities
such as Beijing, Shanghai, Shenzhen and surrounding areas. However, this cycle was highly correlated
with growth in household savings rather than GDP growth. In 2015, the government relaxed regulations
on financial institution deposits, allowing financial institutions to lend out capital locally. This resulted in
explosive savings growth in regional financial centers. The same year savings growth rate in Shenzhen
reached 70%, while savings in Beijing and Shanghai grew by nearly 50%. However, savings growth has
approached 0% since then, and therefore future liquidity may be limited.
Exhibit 41. Changes in Macroeconomic Metrics in Tier One Cities
Source: Wind
Exhibit 42. RMB Savings Growth in Tier One Cities
Source: PBOC, Wind
Fiscal support has led to growth in infrastructure spending. However, due to budgetary constraints, the
same level of expenditure is unlikely. Current progress on reducing overcapacity may imply further
accelerated efforts in the future, imposing additional pressure on industrial growth. We expect 2016
GDP growth to be approximately 6.6%, and 2017 GDP growth to be approximately 6.3%.
Exhibit 43. GDP Growth and Forecast
Source: Wind
0%
5%
10%
15%
20%
Shanghai Beijing Shenzhen
Nominal GDP Growth Housing Price Growth Deposits Growth
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
14-1 14-7 15-1 15-7 16-1 16-7
Beijing Shanghai Shenzhen
6.0%
6.2%
6.4%
6.6%
6.8%
7.0%
15-3 15-9 16-3 16-9 17-3 17-9
Downward pressure
on the economy
remains in 2017,
further slowdown
expected
Liquidity inflection
point observed

We believe the current stagflation environment is a short-term phenomenon, and we are currently at the
mid-to-late inflation cycle. As price increases, value of commodities in asset allocation gradually
reduces. We expect inflation to peak in 2016Q4, and deflationary pressure will appear in 2017.
Exhibit 44. CPI Changes and Predictions (%)
Source: Wind
We are cautious that the zero-interest rate environment may be a long-term trend. As the population
aging continues, the real-estate cycle is peaking. Return on assets will gradually decrease and
gradually approach zero. As housing sales decrease in 2017, we expect the 10-year CGB yield to
approach 2%.
Exhibit 45. 10 Year China Government Bond Yield (%)
Source: Wind
2.2 Potential Effects of the Fed’s Rate Hike on the Chinese Economy
In September, the U.S. Federal Reserve Open Market Committee (“FOMC”) postponed the interest rate
hike with a 7 to 3 vote. The FOMC believes that the U.S. economy has shown consistent recovery in
2016H1, and the labor market remains sound. Although the unemployment rate held steady over the
past few months, employment was relatively stable and household spending has gradually increased.
The FOMC expects the positive trend to continue. However, current sub-2% inflation remains a
concern. In addition, commercial investments remain weak. The FOMC’s decision is consistent with the
market’s general expectations.
2.5
3.0
3.5
4.0
4.5
5.0
10-11 11-5 11-11 12-5 12-11 13-5 13-11 14-5 14-11 15-5 15-11 16-5
10Yr China Government Bond Yield
Interest rate reduction
cycle reinitiates
Inflation over the short
term, deflation in the
long term
PPP Changes (see right)CPI Changes

Exhibit 46. Federal Funds Target Rates Movements (%)
Source: Federal Reserve
The probability for the Federal Reserve to raise interest rates once in 2016 remains high. It is expected
that a December hike may be appropriate due to strong employment and inflationary environment. The
Federal Reserve previously expected two rate hikes in 2016. Not raising the rates in 2016 may damage
the Federal Reserve’s credibility. Data from the futures market indicates a 14.5% probability of a
November hike, and a 59.3% probability of a December hike.
Exhibit 47. Rate Rise is Highly Likely as Priced in the Futures Market
Source: Fedwatch
We expect the rising interest rate cycle to continue into 2017. This will be the weakest rising interest rate
cycle in the Federal Reserve’s history. In September, the FOMC expected the benchmark rate to be
0.6% by the end of 2016, lower than the 0.9% expected in June 2016. This reduces the number of rate
hikes from two to one. Furthermore, the FOMC also revises this figure from 1.6% to 1.1% by the end of
2017, and from 2.4% to 1.9% by the end of 2018. These revisions indicate a slower pace than
previously expected. If one rate-hike is materialized in December 2016, there will be a maximum of two
rate-hikes in 2017.
Considering the dominant position of the U.S. Dollar in the international currency systems, the U.S.
interest rate-hikes exert significant effects on the Chinese economy. The primary means of influence will
be the following.
Due to USD being one of the major reference currencies for the RMB, an interest rate-hike by the
Federal Reserve will cause PBOC to balance between foreign reserves, interest rates, and exchange
rates. This will reduce PBOC’s ability dictate monetary policy. The Chinese government has sufficient
foreign reserves to maintain steady short-term exchange rates when under pressure from a stronger
U.S. Dollar. However, the RMB has yet to become an international currency, and a certain level of
foreign reserves must be maintained. Under the current expectation for the RMB to depreciate, PBOC
must balance between the exchange rate and foreign reserves in the event of a U.S. rate hike.
0
1
2
3
4
5
6
7
91-9 96-9 01-9 06-9 11-9 16-9
Federal Funds Target Rates
0
20
40
60
80
100
16-9 16-10 16-11 16-12 17-1 17-2 17-3 17-4 17-5 17-6 17-7 17-8 17-9
Pre-FOMC Meeting Post-FOMC Meeting
PBOC needs to
balance exchange rate
and foreign reserves
Fed’s December rate
hike likely

a
Furthermore, PBOC must balance between the exchange rate and the interest rate as the spread
between U.S. and China government yield narrows. This would further result in RMB capital outflow and
depreciation. Further interest rate reduction in this environment may result in additional capital controls
in exchange for independence in Chinese monetary policies.
The anticipated U.S. rate hikes would result in global liquidity crunch and indirectly weaken the easing
programs of various countries. Such impact was observed in the first rate hike in 2015. Equity markets
in China, Brazil, Hong Kong, and Russia had all experienced sharp declines. We expect elevated
volatility in risky assets in 2017 as the U.S. rate hike cycle continues.
Global market cycles have been historically associated with the global central banks and their interest
rate policies. Housing bubbles often originate from easy monetary policies. Tightening monetary policies
as a result of foreign exchange pressures are usually the primary catalyst to bursting the housing
bubble. Once the U.S. raises rates, and the RMB faces foreign exchange pressure, then the housing
market may face significant headwinds.
Exhibit 48. Major Stock Market Changes
Source: Wind
-30%
-20%
-10%
0%
10%
20%
30%
40%
Dec 2015-Jan 2016 Jan 2016-Aug 2016
China Brazil Hong Kong Argentina Russia US Japan Germany
France Phillipines India South Korea Mexico UK Indonesia
Headwinds on the
Chinese housing
market
Fed’s rate hike may
cause liquidity crunch

3. Investment Strategies in 2017
3.1 Equity Market Opportunities
3.1.1 Recap of Chinese Equity Markets in 2016
The market has experienced significant volatility in early 2016. The failure of the circuit breaker system,
supply side policy expectations, and global implications of Brexit has resulted in a series of market
downturns. The Shanghai Composite Index began the year at 3,539, and bottomed at 2,737 in January.
The market was under downward pressures from RMB depreciation and the fear of major shareholders
disposing of their equity positions. Throughout majority of 2016, the equity market has been primarily
driven by government policies. Stability of the financial markets has been an important priority for the
current political regime. The two new members of the China Securities Regulatory Commission
(“CSRC”) boast extensive experience in the Chinese financial system. Their progressive track record
represents the government’s commitment to further financial market reforms. The Shanghai Composite
Index has since recovered to 3,085 as of August 31, 2016. In the remainder of 2016, the market will
primarily focus on the next U.S. rate hike as well as its influence on capital flows and the currency. This
remains to be an outstanding factor for investors to maintain a risk-adverse perspective.
Exhibit 49. Shanghai Composite Index and 10-Year Treasury Yield
Source: Wind
Exhibit 50. Major Stock Market Indices since Jan 27, 2016 (%)
Source: Wind
2.6%
2.8%
3.0%
3.2%
3.4%
3.6%
3.8%
2,500
3,000
3,500
4,000
4,500
5,000
5,500
15-01 15-03 15-05 15-07 15-09 15-11 16-01 16-03 16-05 16-07 16-09
Shanghai Composite Index closing price (see left) 10-year treasury yield (see right)
11.28% 11.02%
9.88%
8.66%
7.30%
6.34%
0%
2%
4%
6%
8%
10%
12%
SSE Dividend SSE 50 CSI 300 SSE Composite GEI Composite SME Composite
Market experienced
significant volatility in
early 2016

In the current market, company performance is the key factor to determining stock prices. Sector
allocation and thematic investments mainly revolve around profitability. Among others, SOE reforms and
public-private-partnerships (“PPP”) were major types of thematic investments. Since January 27, 2016,
large-cap indices such as the Shanghai Dividend Index and Shanghai 50 Composite Index delivered
12.2% and 12.1%, outperforming the CSI 300 index. Investment strategies focused on medium
price-earnings ratio, profitability, and large-caps delivered 16%, 19%, and 14% respectively. High
performance sectors in 2016 were alcoholic beverages, stock farming, electric vehicles, and consumer
electronics. Stocks reaching their new highs have an average annualized return on equity (“ROE”) of
14%, higher than 9% of the entire A-share market. This statistic is consistent with the overall sector
allocation and investment themes of 2016.
Exhibit 51. Style Index Changes since Jan 27, 2016
Source: Wind, as of Sep 22, 2016
Exhibit 52. Stocks Reaching New Highs Outperformed A-Shares in 2016H1
Source: Wind
Exhibit 53. 10 Best Performing Investment Themes since Jan 27, 2016
Source: Wind
1.77%
15.79%
14.36%
12.79%
16.54%
18.55%
10.01%
12.23%
14.00%
0%
4%
8%
12%
16%
20%
HighP/E
MediumP/E
LowP/E
Non-
performing
stocks
Micro-profit
stocks
Bluechip
stocks
Smallcap
Midcap
Largecap
-10%
0%
10%
20%
30%
40%
50%
60%
Growth of profit attributive to parent
companies
Annualized ROE EPS
Stocks making new highs (off-the-run stocks excluded)
A-share overall
169%
51% 51%
43% 43% 41% 40% 39% 38% 37%
0%
50%
100%
150%
200%
Sub-NewStocks
OLED
LithiumBattery
Decorations&
Gardening
Construction&Energy
Efficiency
Water&Hydropower
RareEarths&
Magnets
NewMaterials
Graphene
SmartGrid
Fundamentals dictate
equity prices

Exhibit 54. 10 Worst Performing Investment Themes since Jan 27, 2016
Source: Wind
Exhibit 55. Sector Valuations and Price Changes
Source: Wind
3.1.2 Equity Investment Opportunities in 2017
Investors should take a long-term view on the China A-shares market. The Shanghai Composite Index
grew 29 fold since its inception on December 19, 1990 at a compound annualized growth rate (“CAGR”)
of 14.0%. The free-float-weighted A-shares market grew 74 times at CAGR of 18.2% during this period.
If a portfolio of RMB-weighted A-shares equities was reinvested at the beginning of each year and
additional RMB-weighted investments were added to new issues in the prior year, the portfolio would
have grown by 576 times at CAGR of 28.0%. Over the same period, a share-weighted approach would
-4%
-1% -1%
1%
2%
3%
6% 6% 7% 7%
-6%
-4%
-2%
0%
2%
4%
6%
8%
OnlineTravel
IPtrafficMonetization
E-Sports
OnlineCelebrityEconomics
Anime
MajorSOEsrestructure
AircraftCarrier
Cross-borderE-Commerce
InternetLottery
GeneticTests
Appliances
Food & Beverage
Electronic Components
Construction Materials
88.14
Chemicals
Automobile
Telecom
Comprehensives
Pharmaceuticals
Light Manufacturing
Non-Banking Finance
Agriculture & Farming
Construction
Power Equipment
Banking
Textiles
Oil & Gas
Real Estate
Machinery
Power & Utilities
Coal
Commerce & Retail
Steel
National Defense & Military
Catering & Tourism
Computers
Transportation
Media
x
10x
20x
30x
40x
50x
60x
70x
80x
90x
100x
-5% 0% 5% 10% 15% 20% 25% 30%
P/EMultiple(TTM)
Sector Price Change (%)
Bullish over the long
term, expect volatility
in the short term

grow the portfolio by 256 times at CAGR of 24.0%. Major asset classes also yielded phenomenal
returns. Between 2000 and 2015, residential properties in China grew by CAGR of 5.1% while the same
figure grew at CAGR of 24.0% in tier-one cities. Over the same period, 10-year Chinese treasury bonds
provided 3.5% yield to maturity. In the worst case scenario, assuming equal quantities of stocks were
purchased at the Shanghai Composite peaks (2,245 in 2001, 6,124 in 2007, 3,478 in 2009, and 5,178
points in 2015) and held to August 2015, the holding period return would be 168%, 105%, 128% and
-22% respectively. The market was dominated by a series of fluctuations within a narrow band.
Between April and August 2016, the market’s monthly range was 5.7% while weekly range was 3.0%.
There were two similar occurrences over the past 12 years. January to May of 2013 saw monthly and
weekly ranges of 6.2% and 3.4% respectively, while October 2013 to June 2014 saw 6.3% and 2.9%
respectively. These two narrow-range-bound markets were during periods of stable macro
fundamentals and liquidity. External catalysts were required to break the bounds. The market will likely
to be range-bound until domestic and international regulators offer additional clarity on further actions.
90% of the price fluctuations in both bullish and bearish markets can be attributed to company
valuations. In a volatile market where valuations decline, company profitability help to anchor and
support share prices. We expect that the market will continue to fluctuate over the medium term, and
company performance will be the primary factor for stock selection. Emerging industries and industries
with reasonable valuations and performances may offer attractive opportunities. We believe sectors
where companies report annual earnings growth of 15% or more and PEG ratio of 1.2 times or lower are
reasonable targets. These are mostly consumer-focused sectors including household appliances, food,
agriculture, real-estate, and computers. Emerging industries such as education, fitness, high-end
equipment, and automated manufacturing may also deliver strong performance. For over a decade, the
accelerated industrialization featured a population with average age between 30 and 40 years old. The
1970’s generation was the primary buyers of consumer discretionary goods, including durable goods
such as housing and automobiles. The millennials born between 1985 and 2000 are entering their
primes where they have larger appetite for consumer discretionary services such as education, fitness,
and entertainment. We expect the real-estate market to moderate after square-footage sales peaked in
2013, and consumption of emerging products and services should pick up. Since 2010, the global
automobile industry is undergoing a new era of revolution through innovation. This is driven by
extensive integration and implementation of improved mobility, artificial intelligence, and sharing.
Automobile manufacturers and technology conglomerates have invested unprecedented amounts of
capital and resources to transform their offering. This is expected to facilitate the development of related
industries in China, such as high-end manufacturing and smart-cars.
Exhibit 56. Shanghai Composite Index Underestimates Investment Returns in A-Shares
Source: Wind
14.0%
18.2%
24.0%
28.0%
0%
5%
10%
15%
20%
25%
30%
SSE Composite Free-float-weighted Share-weighted RMB-weighted
CAGR since SSE establishment
Company profitability
dictates stock prices
during market
turbulence

Exhibit 57. Even Invested at Market Peaks, A-Shares Equities Paid Off in the Long Term
Source: Wind
3.2 Fixed Income Opportunities
3.2.1 RMB’s Inclusion into the SDR Basket
On November 30, 2015, the International Monetary Fund (“IMF”) announced the decision to include
RMB into the Special Drawing Rights (“SDR”) basket. The change had taken effect on October 1, 2016:
the SDR basket currently have a RMB weight of 10.92%, with dollar, euro, yen and pound weighting
41.73%, 30.93%, 8.33% and 8.09%, respectively.
Exhibit 58. Composition of SDR Before and After RMB Inclusion
Source: Wind
In the longer term, there can be hundreds of billions of dollars flowing into the Chinese capital markets
as a result. The inclusion into the SDR is effectively labeling the RMB as a “hard currency”. As a result
central banks and sovereign wealth funds will increase their allocation of RMB assets. In the current
global government reserves, the shares of dollar, euro, pound and yen are approximately 63.8%,
22.5%, 4.7% and 3.8% respectively, while RMB’s share is only 1.1%. Once RMB is included in the SDR,
global central banks’ demand for RMB-denominated assets can grow substantially. The growth will be
$210 billion if the share of RMB in the international reserves matches the yen or $290 billion if it does
the pound. Meanwhile other overseas institutions will also increase their demands for
RMB-denominated assets, which is even more significant.
168%
105%
128%
-22%
176%
58%
98%
-35%-50%
0%
50%
100%
150%
200%
Since 2,245 in 2001 Since 6,124 in 2007 Since 3,478 in 2009 Since 5,178 in 2015
RMB-weighted investment Share-weighted investment
41.9%
37.4%
0.0%
9.4%
11.3%
41.7%
30.9%
10.9%
8.3% 8.1%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
USD Euro RMB JPY GBP
Before SDR Inclusion After SDR Inclusion
RMB’s SDR inclusion
will further drive
foreign capital to
China

Exhibit 59. Shares of Major Currencies in Total Official Foreign Reserves
Source: COFER
Exhibit 60. Global Official Foreign Reserves Held in Yen-Denominated Assets
Source: COFER
Since the financial crisis of 2008, quantitative easing policies adopted by developed economies such as
U.S., Europe and Japan quickly led to zero or even negative yields in the short term. High-yielding
assets will be rare to find. Although China has also loosened its monetary policy, the magnitude is far
from the quantitative easing programs in Europe and U.S. and the current interest rates are still at a
high level. Current U.S. 10-year government bond yield is at 2.22%, Eurozone at 0.58%, and Japan at
0.32%, while China is at 3.04%.
Exhibit 61. 10-Year Government Bond Yield-To-Maturity of China, U.S., Europe, and Japan
Source: Wind
Hence China’s bond market is more attractive to long-term institutional investors including central
63.6%
20.4%
4.8% 4.1% 2.0% 1.9% 0.3%
3.0%
0%
10%
20%
30%
40%
50%
60%
70%
USD EUR GBP JPY CAD AUD CHF Others
0%
1%
2%
3%
4%
5%
6%
7%
8%
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
1995 2000 2005 2010 2015
Claims in JPY (Billions) % of Total Reserves (Right)
-1%
0%
1%
2%
3%
4%
5%
6%
07-1 07-7 08-1 08-7 09-1 09-7 10-1 10-7 11-1 11-7 12-1 12-7 13-1 13-7 14-1 14-7 15-1 15-7 16-1 16-7
U.S. EU Japan China
Chinese debt market
attractive to
international investors
with its higher interest
rates

banks, offshore RMB clearing banks, pensions and insurance companies. As of August 2016, overseas
institutions registered with ChinaBond have invested 633.8 billion RMB in the Chinese interbank bond
market, only 2.15% of the total market. In comparison, foreign institutions held 23% of Korea’s
government bond, and in Japan’s case this is 8% and in U.S., nearly 48%. As more and more foreign
investors enter China’s bond market, we shall see the bond market growing in both size and activity.
Exhibit 62. Size and Percentage of Bond Held by Overseas Institutions
Source: ChinaBond Custody
Fixed income products with high ratings and low risks may be the primary investment target, and the
long-end yields are again moving downward. Specifically, foreign capital will still favor treasury bonds
and financial bonds featuring high transparency, liquidity, and low risk. As of the August 2016, overseas
institutions held 54% of their total debt investments in Treasury bonds, and 39% in financial bonds, yet
only less than 10% in the more risky credit bonds.
In addition, the nascent onshore SDR bond is another important instrument for investors. For instance,
the debut SDR bond in China, dubbed a “Mulan bond”, was issued on August 31 and has sold 500
million SDR, equivalent of $700 million. The 3-year bond was subscribed 2.47 times and the 0.49%
yield was set at the lower bound of its range (0.4%-0.7%).
Exhibit 63. Composition of Chinese Debt Held by Overseas Institutions
Source: ChinaBond
1.5%
1.6%
1.7%
1.8%
1.9%
2.0%
2.1%
2.2%
2.3%
0
100
200
300
400
500
600
700
14-6 14-9 14-12 15-3 15-6 15-9 15-12 16-3 16-6
Overseas Institutional Holding (RMB Billions) Composition (%)
CGB
54%
CDB
19%
Corporate
3%
Others
1%
MTN
3%
EXIM
9%
ADBC
11%
Fixed income
products with high
rating and low risks
are attractive targets

3.2.2 Fixed Income Investment Opportunities in 2017
The government bond yields of major developed countries have continued to decline since 1980. The
U.S. 10-year Treasury yield dropped from over 10% to the current 1.6%-1.7%, and Japan’s 10-year
yield declined from 5% at the end of 1980s to the current -0.1%. The world has entered an era of low or
even negative interest rates.
Exhibit 64. Interest Rates in Major Developed Countries Sliding to New Lows (%)
Source: Wind
The drivers behind the global low interest rates mainly include: 1) disappearing demographic dividend
slowing down the economy. As a countermeasure, central banks scrambled to adopt monetary easing
policies and have thrown interest rates onto a long-term downtrend. 2) Declining return of the real
economy is driving capital out of the real economy and into financial assets. Treasury yields are thus
“bought down” by the newly allocated capital. 3) With the lingering deflation expectation and limited
sources for long-term growth, the marginal effect of quantitative easing has weakened, resulting in low
interest’s self-fulfilling cycle.
Exhibit 65. Dependency Ratio in China
Source: Wind
-2
0
2
4
6
8
10
12
14
16
80 83 86 89 92 95 98 01 04 07 10 13 16
S. Korea Japan Germany U.S.
0
20
40
60
80
100
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Youth as % of Population Seniors as % of Population Total Dependency Ratio
Zero interest rate will
be the long-term trend

China’s interest rates will remain low for a long time regardless of perspective, demographic and real
estate, return on capital, or government leveraging. Firstly, with the aging population, the dependency
ratio of population bottomed at 36% in 2010, and the property boom has passed its peak and will be
followed by declining demand. Secondly, with the future excess capital and labor shortage, the balance
will shift to the labor force causing return on capital to decline. Lastly, the government is leveraging up
and replacing local government debt in order to prevent extensive economic slowdown. A low-rate
environment will be necessary for the government to succeed.
Since the onset of the monetary easing cycle in 2014, the Chinese bond market has seen a bull market
of more than two years. In August 2016, the 10-year treasury yield had broken the support of 2.7%
toward 2.6%, and the 10-year CDB has also moved to its new low of 3%. This bond bonanza will likely
continue over a long period.
Exhibit 66. 10-Year Government Bond Yields (%)
Source: Wind
Interest rates are expected to hit new lows in 2017. The pressure of economic slowdown will be
relatively high in 2017. Chinese corporations are pressured by low profitability. Total profits from the
industrials grew negatively in 2015. With the shrinking investment in manufacturing, the economy had to
be supported by real estate and infrastructure. In real estate, the growth of investment during 2016H1
has picked up together with the sales growth. Home buyers took out large amount of mortgage loans,
accounting for about half of the monthly average of 1 trillion RMB lending so far this year. However, the
leverage growth from the household source has reached its capacity so the rapid growth of property
sales is not going to last. In infrastructure, the investment is constrained by the financing. The
infrastructure investment’s supporting function would be mitigated should the financing lag behind.
Moreover, PPP’s support to the infrastructure will unlikely meet market expectations given that PPP
projects’ execution rate is still low.
In our view, although the economic slowdown will continue in Q3 and Q4 of 2016, current production
activity is relatively stable and better than the market’s earlier gloomy forecast. There is a risk that
inflation may rebound in the fourth quarter and peak around that time due to the base effect. And then in
2017 deflation pressure will come back, taking the long rate back to the downtrend.
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
02-9 04-9 06-9 08-9 10-9 12-9 14-9 16-9
10-Yr CGB Yield to Maturity 10-Yr Policy Bonds Yield to Maturity
Inflation in the short
term and deflation
pressure may
resurface in 2017
2017 bond market
outlook is optimistic

Exhibit 67. Investment Growth
Source: Wind
Exhibit 68. Historical CPI and PPI and Forecasts
Source: Wind
Monetary policy is stable in the short term, but still has possibility of easing over the longer horizon. The
reasons for the current stable monetary policy include: 1) The short-term economic fundamentals have
stabilized and inflation has risk of rebounding. 2) The exchange rate needs to remain stable given the
possibility of another Fed rate hike. 3) To prevent asset bubbles. 4) To control leverage in the bond
market. However, economic fundamentals are the key to monetary policy. If in 2017 the economy faces
further pressure of slowdown and real return rate slides, the monetary easing will come rather late than
not.
Asset allocation needs will support interest rates. Many non-standard assets and negotiable convertible
debentures will mature this year. The maturing fund from wealth management products and insurance
will continue to turn to the bond market opportunities due to the impact of financial deleveraging on
non-standard products and the shortage of high-yield assets. In the meantime, corporate loans on bank
balance sheets continued to drop while mortgage is the only thriving lending business. In addition, the
funds led by the rural and municipal commercial banks are also rushing into the bond market in search
for yield.
Optimistic about the opportunities in 2017, interest rates are expected to hit record lows. We believe that
the down movement of short-term interest rate is limited and the bond market will be dominated by
fluctuations. However, faced by the high base in 2016, property sales in 2017 are expected to peak
followed by pullback. Next year China's economy will likely remain under the slowdown pressure and
monetary easing will be inevitable. Coupled with the asset allocation needs, record low interest rates
can be expected. It will be a great opportunity to add positions for next year If treasury yield in Q4
-5
0
5
10
15
20
25
30
35
11-7 12-1 12-7 13-1 13-7 14-1 14-7 15-1 15-7 16-1 16-7
Capital Investment YoY Growth Infrastructure Investment YoY Growth
Real-Estate Investment YoY Growth Manufacturing Investment YoY Growth
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
15-1 15-4 15-7 15-10 16-1 16-4 16-7 16-10 17-1 17-4 17-7 17-10
CPI & Forecast PPI & Forecast
Interest rates are
expected to hit record
lows
Monetary policy stable
in the short term

adjusts to the upper bound of its band or even higher.
From the fundamentals, China's real estate demand can hardly be said to have improved and is getting
closer to the turning point; Governments' revenue and expenditure balance has stretched and
infrastructure investment is not optimistic either. The economic downward pressure will remain high,
therefore we will be long-term bullish on the bond market. This year the 10-year Treasury yield has
already broken the 2008 low of 2.7% and is likely to break the 2002 low of 2.3% in 2017.
Interest rates may be able to touch the long-term bottom. In 2002, 2006 and 2008, the deterioration of
the economic fundamentals and deflationary pressure were the leading factors that drove the Treasury
yields to low levels. In the medium term, China's manufacturing investment will be constrained by
overcapacity, and the decline of real estate investment will be unavoidable once the demographic
dividend disappears. But the infrastructure investment can only support the bottom, so investment will
be under pressure. Combined with limited income growth and real estate's crowding out effect on,
China's future economic growth may be lower than in 2008, causing interest rates to bottom.
Table 2. Comparison of Market Fundamentals during Low Yield Markets
Time
GDP
Growth
CPI Growth
10-Yr CGB
Min. Yield
Economic Environment
2002 8%-10% -1%-1% 2.30%
Urbanization initiated
post-Asian Financial Crisis
2006 >12% 1%-2% 2.80%
Economic expansion
Low inflation environment
Rising rate cycle
2008 6%-7% -1%-2% 2.70%
Population dividend remains
Real-estate boom
4 trillion RMB stimulus
package
2016 and
after
6.5%-7%
Short-Term
1.3%-2%;
Deflationary Risk
Impending
New Lows
Expected
Demographic dividend
disappearing
Property market at inflection
point
Excess capacity in industrials
Infrastructure remains strong
Source: Wind, ChinaAMC Estimates
Lending cost angle: loan rate should match bond's yield. The yield on 10-year Treasury bonds should
be commensurate with the rate of return on loans after the costs of capital and taxes. The current
lending rate is about 5.25%, corresponding to the 10-year Treasury yield of around 2.75% and 10-year
China Development Bank (“CDB”)’s 3.1%. For bond yields to move lower, it will need the lending rates
to move down further, which in turn will depend on more monetary easing policy.
Asset allocation of wealth management products (“WMP”): Bond yield on the asset side of WMP needs
to cover the cost on the liability side. Using a leverage ratio of 2 and interest rate of 2.2% -2.3%, we
estimate the bond yield in WMP can be covered. Current yield of WMP remains at 3.9%, corresponding
to 10-year CDB yield of 3.1% and 10-year Treasury yield of 2.7% -2.75%. Future trend will depend on

how far interest rates and the cost of WMP will go down.
In our view, interest rates may be pushed down if one or more of the following conditions emerge:
downward adjustments of the repo-rates rates, further monetary easing, declining property sales and
peaking inflation.
Table 3. Short-Term Yield (2016Q4) Target Range on Rate Bonds
Metric Evaluation
CGB Yield
Target
CDB Bond
Yield Target
Fundamentals
Comparing fundamentals in ’02, ’06,
and ’08
2.5%-2.7% 2.9%-3.1%
Term Spread
R007 remains low, term spread of 60bps,
relatively reasonable
2.5%-2.8% 2.9%-3.2%
Allocation by
WMPs
Wealth planning costs covered by
government bonds under 2x leverage
2.5%-2.7% 2.8%-3.1%
Lending Cost
Loan rate should be comparable to
government bonds after cost of capital and
taxes
2.55%-2.7% 2.9%-3.1%
Source: ChinaAMC

Contact Information
China Asset Management Co. Ltd.
Address: Level 8, Tower 7, One Yuetan Street South, Xicheng District, Beijing, China, 100045
Website: www.chinaamc.com
Email: ib@chinaamc.com
Important Information
This report is intended only for the use of our clients and prospects. Neither this report nor any of its contents
may be reproduced or published for any other purpose without the prior written consent of China Asset
Management Co. Ltd (“ChinaAMC”). All the investment strategy illustrated in this report was made on a
preliminary basis only, no representation or warranty is made as to the efficacy of any particular strategy or
the actual returns that may be achieved.
The information in this report reflects prevailing market conditions and our judgment as of this date, which
are subject to change. In preparing this report, we have relied upon and assumed without independent
verification, the accuracy and completeness of all information available from public sources. We consider the
information in this report to be reliable, but we do not represent that it is complete or accurate. ChinaAMC, its
affiliates, directors, officers or employees accept no liability for any errors or omissions relating to information
available in this report, and will not be liable for any damages or costs arising out of or in any way connected
with the use of the information provided in this report.
Any information given or representation made by any dealer, salesman or other person and (in either case)
not contained herein should be regarded as unauthorized and, accordingly, should not be relied upon.
Accordingly, no person receiving a copy of this report in any territory may treat the same as constituting an
invitation to him to purchase or subscribe for the participating shares of the Fund nor should he in any event
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lawfully made.

2016/17 China Macroeconomic Outlook & Market Opportunities

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