For the first half of 2021, the Matthews Pacific Tiger Fund returned 5.58% (Investor Class) and 5.64% (Institutional Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 6.51% over the same period. For the quarter ending June 30, the Fund returned 3.95% (Investor Class) and 3.98% (Institutional Class), while the benchmark returned 3.66%.

Market Environment:

The debate around pricing pressures manifesting into higher inflationary expectations continues to have an influence on Asian equities along with other factors like regulatory changes, and the evolution of corporate earnings.  The regulatory developments in China present some uncertainty even as the government is trying to grapple with a variety of issues like anti-monopoly, data privacy, and welfare rights (especially, for workers in the gig economy) that stem from the emergence of platform type business models. 

The MSCI Asia ex Japan Growth and Value indices were about neck-and-neck in the second quarter, both gaining about 3% after Value outperformed growth in the first quarter. Small caps outperformed the large caps for the fifth consecutive quarter reflecting investor optimism towards a broadening in economic recovery. 

For the region, earnings have generally been revised upwards since the start of the year led by South Korea and Taiwan, although COVID-impacted regions like Indonesia and Philippines have seen some retracement in forward expectations. Sectors like industrials and materials have been the best performing year to date, as investors anticipate a reflationary environment to favorably impact earnings.

Asian currencies depreciated against the U.S. dollar during the first half but in an orderly way, even as nominal U.S. yields are starting to move higher, reflecting the buildup of foreign reserves albeit weaker fiscal positions stemming from loss of economic activity. 

Performance Contributors and Detractors:

Stock selection in South Korea was a contributor to performance, especially within the portfolio’s industrial and internet holdings, such as HMM Co. and NAVER Corp. South Korean industrial shipping company HMM has performed well throughout the first half of the year given its restructuring efforts during the industry’s consolidation which set up the company to be well positioned to enjoy a positive operating environment. Search engine and internet content provider NAVER’s continued transformation of its business model into an e-commerce platform is increasingly being recognized by investors as the company continues to solidify its leading position in South Korea by building open ecosystem around e-commerce development in the country. In addition, stock selection in the utilities sector such as Tata Power Co. in India and ENN Energy Holdings in China performed well. Tata Power Co. and ENN Energy Holdings both have leading positions in clean energy utilities such as solar power and natural gas distribution. In particular, China’s ENN Energy benefited from the continued recovery of the industrial demand in the country combined with the government’s efforts to reduce its carbon footprint in the coming decades.

On the other hand, domestically oriented holdings in Southeast Asia, including the Philippines and Indonesia, were detractors. These two countries’ recovery from the pandemic has taken a longer path. Thus, traffic to the Philippines’ SM Prime Holding’s shopping malls and the loan demand for Bank Central Asia in Indonesia have not fully recovered, and uncertain near term-prospects dragged both stock’s performance. Additionally, the portfolio’s internet holdings in China, including Alibaba Group Holdings and Beijing Kuaishou Technology Co., detracted from performance amid a changing operational environment as competitive and regulatory pressures continue to intensify. While both Alibaba and Kuaishou are delivering strong execution in their own rights, the changing landscape would mean that they need to invest more and near term profitability may be impacted.

Notable Portfolio Changes:

As part of our continuous efforts to position the portfolio towards durable earnings growth, we made a few changes, especially in the industrial sector. We rotated capital from Weichai Power Co., a heavy duty truck manufacturer in China, and initiated a new position in Shenzhen Inovance Technology Co., an industrial automation component manufacturer. Although both Weichai and Shenzhen Inovance are leaders in their respective industries, we view the long-term market share gain potential of Inovance with a strong track record of the management team to be better.

We also rotated capital from South Korean utility company Korea Electric Power Corporation (KEPCO) and initiated a position in Doosan Bobcat Inc., a leading construction equipment company in South Korea gaining market share in the U.S. and Europe. In the past, Bobcat has shown strong execution capability in integrating its acquisition and expanded distribution network in developed countries. Compared to KEPCO, where our expected milestone of the electricity tariff faced political challenges, Bobcat’s prospects are expected to be better as they start to display new product development capability in addition to its channel expansion.

Outlook:  

Looking ahead, several crosscurrents are likely to have an impact on Asian equities in the near to medium term. These crosscurrents may affect the evolution of earnings across the region, especially as the monetary and fiscal policy environment continues to unfold in China, and as inflationary pressures evolve in coming periods.

One of the biggest unanswered questions concerns pricing pressures, some of which reflect consumer demand that is running ahead of constrained supply chains. While the consumer demand recovery has been impressive, it is quite likely that the pattern of consumption will shift towards personal experiences. As the pandemic continues to abate, it is also possible that labor and other transportation-related bottlenecks will further ease (barring further interruptions from the coronavirus).

That being said, there are structural changes in China’s industrial landscape that might continue to have lasting impact on the global economy. China’s authorities continue to impose stricter environmental regulations on polluting sectors, and are encouraging a shift towards higher value-added production.  Furthermore, Chinese entrepreneurs may be hesitant in committing significant CapEx considering the uncertainty from tariffs and duties.  While this may present an opportunity for an augmentation in supply chains elsewhere, the process may not be smooth and there could be intermittent mismatch between supply and demand. 

We believe the core of the portfolio continues to be invested in businesses capable of delivering durable earnings growth accompanied by solid cash flow. There are many subsectors such as housing in India and digital e-commerce in Southeast Asia which may have long runways for growth. In addition, we continue to look for Chinese businesses that are taking long strides in closing the technology gap with the West, and may start to substitute imports. The opportunity set continues to broaden and widen, and the portfolio team remains focused on finding uncorrelated and diversified long-term growth in Asian equities.

As of June 30, 2021, the securities mentioned comprised the Matthews Pacific Tiger Fund in the following percentages: HMM Co., Ltd., 1.0%; NAVER Corp., 2.0%; Tata Consultancy Services, Ltd., 1.1%; ENN Energy Holdings, Ltd., 2.3%; SM Prime Holdings, Inc., 1.7%; PT Bank Central Asia, 1.0%; Alibaba Group Holding, Ltd., 3.9%; Kuaishou Technology, 0.8%; Shenzhen Inovance Technology Co., Ltd., 1.1%; and Doosan Bobcat, Inc., 1.0%. The Fund held no positions in Weichai Power Co. and Korea Electric Power Corporation.

Current and future portfolio holdings are subject to change and risk.

Average Annual Total Returns - MAPTX as of 06/30/2021