For the year ending December 31, 2021, the Matthews Korea Fund returned -0.33% (Investor Class) and -0.16% (Institutional Class), while its benchmark, the Korea Composite Stock Price Index (KOSPI), returned -4.79% over the same period. For the fourth quarter of the year, the Fund returned 1.16% (Investor Class) and 1.15% (Institutional Class), while the benchmark returned -3.44%.

Market Environment:

Strong upside momentum from 2020 buoyed South Korean equities into the first half of the year, with the KOSPI peaking in July, but the market finally cooled during the second half of the year. The combination of low valuations, a rebound in earnings and a cyclical bounce that propelled the market higher were offset by rising interest rates, slowing global growth, and a clampdown on household borrowing.

The information technology sector, the largest sector in the economy, was hit by a global chip shortage, weighing the export heavy market. Concerns over expensive stock valuations also prompted large institutional investors such as the country’s national pension fund and foreign investors to take profits, pushing the market lower.

We believe that most major emerging economies, particularly Korea, are ahead-of-the-curve in terms of tightening liquidity and raising rates which should support equity valuations going forward.

Performance Contributors and Detractors:

The Fund’s allocation and stock selection within information technology and communications services sectors contributed the most to the Fund’s relative performance for the full year. Among individual stocks, Hana Materials, a manufacturer and supplier of silicon materials for semiconductor products was among the top contributors. Hana Materials quickly gained market share over the course of the year by enhancing customer service, innovating their product line and meeting the demand for localization while diversifying its customer base and revenue streams. KB Financial Group, one of South Korea’s largest banks, was another significant contributor to absolute performance. KB Financial has seen improving earnings accompanied by historically low valuations. With credit costs well controlled and interest rates stable, we believe there is room for net interest income to improve.

On the other hand, the Fund’s allocation and stock selection within materials and consumer staples sectors detracted the most from performance. LG Chem, the largest Korean chemical company, was a notable detractor to performance. Traditionally considered a petrochemical business, LG Chem has been aggressively investing in its electric vehicle (EV) battery business over the last several years. The stock suffered due to its lithium-ion storage battery recalls. LG Chem recognized the recall costs and spun off its battery business to a large Chinese player. However, we are comfortable with LG Chem’s remaining businesses and believe the company’s earnings will continue to be robust as its customer base gains momentum outside the Chinese market. Samsung Electronics, a multinational electronics manufacturer that is a world leader in smartphones and various components such as lithium-ion batteries, PC memory chips, image sensors and displays, was a detractor to absolute performance. Despite enjoying both solid PC memory prices and demand, investors’ concern about potential memory demand deterioration from the fourth quarter of 2021 into 2022 weighed on the stock. We believe Samsung Electronics is trading at an attractive valuation, and improving capital management practices such as improved shareholder policies along with sensible mergers and acquisitions may rerate the stock.

Notable Portfolio Changes:

During the quarter, we initiated a position in Mando Corporation, a fast-growing automobile parts manufacturer and supplier. Mando spent significant research and development (R&D) dollars developing cutting edge software for electronic vehicles, specifically targeting the growing Chinese market. While the sector was hit by chip shortages, we believe moving forward the market will normalize and Mando will be able to take advantage of a growing customer base and be the beneficiary of improved earnings.

We exited our position in K Car, an online used car retailer. After participating in the IPO, the stock price doubled, exceeding our expectations. We took a profit and sold our position as we believe the company’s valuation now looks expensive. We maintain a positive view of K Car and will be closely monitoring the company, tactically reinitiating a position if warranted.

Outlook:

South Korea has yet to see a boom in consumption, but looking ahead, we anticipate it will gradually improve during the coming year. Higher vaccination rates and potentially more fiscal stimulus after the presidential election in March should also boost growth. The ruling progressive party’s candidate leans left supporting more social spending and fiscal expansion while the main conservative party candidate favors lower interest rates and growth of the private sector. Both candidates seem to support structural reform, deregulation and the promotion of green industries.

We remain focused on active security selection, concentrating on groundbreaking companies we believe are positioned to benefit from strong cash flows and the global recovery. We continue to look for companies that can benefit from domestic consumption, as well as South Korean companies effectively competing and innovating in global markets. We are confident the pioneering companies we’ve invested in will continue to show improved cash flows and long-term growth potential.

As of Dec 31, 2021, the securities mentioned comprised the Matthews Korea Fund in the following percentages: Samsung Electronics 17.4%, KB Financial Group 4.6%, Hana Materials 4%, LG Chem 3.1%, Mando Corporation 1%.

Current and future holdings are subject to change and risk.

Average Annual Total Returns - MAKOX as of 12/31/2021