For the quarter ending March 31, 2021, the Matthews Asian Growth and Income Fund returned 2.22% (Investor Class and Institutional Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 2.75%. 

Market Environment:

The first six weeks of the year continued the pathway that followed the coronavirus pandemic of last March—a steady and significant move upward. That appeared to change in the middle of February as the reality of lofty valuations and expectations were brought to the forefront of investors’ minds given a steepening yield curve across much of the globe with inflation beginning to rear its head. Shipping costs, oil prices, metal prices and soft commodities were all seeing increases. The rise in longer dated bond yields helped to spark somewhat of a rotation away from the conceptual growth stocks with limited near-term earnings but much promise, and caused a bid for more classic “value” stocks including banks and commodities.

The rotation thus far has been mild in Asia, with many growth stocks still in positive territory year-to-date but it has created downside volatility for the first time in many months. And this potential shift remains a key focal point as the U.S. embarks upon ever greater fiscal stimulus. This dynamic drove the less innovation-heavy developed parts of Asia such as Hong Kong and Singapore to be two of the stronger performing markets during the quarter, although the region was led by technology-heavy Taiwan as we are in the midst of a strong tech cycle. Parts of Southeast Asia such as Indonesia, Malaysia and the Philippines lagged given weaker currencies and rising COVID restrictions in the case of the latter two countries.  

Performance Contributors and Detractors:

The largest contributor to performance came from the portfolio’s technology sector as Taiwan Semiconductor Manufacturing gained. The company enjoys a strong competitive position as the world’s leading foundry with superior technology, and the current backdrop for silicon demand has been decidedly strong driven by structural trends including high performance computing and 5G adoption. This led management to announce a US$100 billion capital expenditure plan for the next three years, demonstrating the enormous scale of demand it enjoys. Elsewhere within technology, services provider Tata Consultancy Services rose on guidance for the next year, targeting double digit revenue growth as it believes it can win large deals as IT spending recovers, particularly within banking and financial services.

The Fund’s holdings within the industrial sector also benefited performance with power tool manufacturer Techtronic rising rapidly. The company once again gained market share from competitors and was helped by the stay at home DIY boom, growth of its new outdoor cordless equipment and excitement over its role in U.S. infrastructure spending. Property management company Ever Sunshine Limited rallied as it beat earnings expectations, delivering over 80% growth for 2020 as it won third party contracts and grew its value added services.

The consumer discretionary sector was the largest detractor to returns, with auto parts supplier Minth Group the weakest of these. The stock struggled with declining revenues in 2020 due to COVID-induced demand drops for its auto customers and there are concerns that this will continue into the first half of 2021 given chip shortages for auto makers. Chinese appliance manufacturer Midea Group fell on concerns that rising raw material prices will hurt margins while South Korean life care solutions provider COWAY dropped on rising domestic competition for its water purifier business as well as higher costs. Elsewhere, gold miner Northern Star Resources struggled against a declining gold price and the convertible bond in e-commerce retailer Pinduoduo dropped after strong performance in 2020 and as competition in group buying in China heats up.

Portfolio Changes: 

A number of alterations were made to the portfolio during the quarter with six new positions, including two in convertible bonds. These included increasing our weight in domestic China as the market struggled during the first quarter. ENN Natural Gas was added as the firm has restructured where the majority of its value comes from its holding in gas distribution company ENN Energy. We like the company as we believe it can deliver double digit profit growth as gas connections and usage rise, while it is also attractively valued at only 6x EV/EBITDA and offering a 1.8% dividend yield. Sports retailer Topsports was another addition as the firm is a leading partner in China for selling Nike and Adidas products. Similarly we expect that the company has an attractive growth outlook given a growing category, increasing its share with brand partners and improving store profitability. E-commerce retailer JD.Com was another addition as we believe the company will likely gain share from Alibaba and improve margins over time as it pushes into new categories and benefits from its focus on selling authentic items and its strong logistics. We also believe that there is significant value on offer given a raft of investments including in fintech, logistics, cloud, and health care as well as maintaining a very large cash pile.

Elsewhere we initiated a position in Australian casino and digital game maker Aristocrat. We expect solid growth as casinos recover, the company gains yet more share from superior products and as it executes on digital. Within convertible bonds, we added positions Chinese pharmaceutical company Hansoh and in an exchangeable of Malaysian bank CIMB. These additions were funded through the exit of equity positions in China Resources Land, CLP Holdings, China Yangtze Power, Singtel, Hanon Systems, Vinamilk alongside a Baozun convertible bond.

Outlook:

The macroeconomic environment appears relatively robust as the unprecedented wave of monetary and fiscal stimulus enacted globally has been bolstered yet further while COVID infection rates are generally dropping and vaccine rollouts have begun, albeit this differs markedly by country. The increase in domestic savings rates and potential for a further boost from infrastructure spending will likely spur the U.S. to strong economic growth. Accompanying this is also likely to be solid growth from China as the recovery continues with economic data already demonstrating some form of a return to normalcy.

With the world’s two largest economies driving global economic growth higher, the backdrop appears reasonable for risk assets. However, there are some issues to be wary of. Firstly, not all countries are likely to enjoy such a swift return to growth. Further, higher deficits come with prospective balance sheet risks down the line and tax hikes are inevitably part of the conversation. These policy moves will also likely continue to drive yet higher inflation expectations and this has already impacted yield curves across the globe. What appears to be boundless stimulus has driven equity valuations to levels that are rather frothy, exemplified by high retail participation and arguably illogical investment vehicles such as SPACs and the more bizarre, newly created non-fungible tokens market. One needs to be wary of such euphoria, particularly as rising rates increases the cost of capital.

As a quality-oriented growth and income portfolio, we are naturally more inclined toward businesses that can deliver a combination of high profitability, visible EPS growth and sustainable dividend yields. We believe that these ongoing changes in policy and a broader economic recovery may produce a fruitful backdrop for portfolio returns as investors become more discerning. Further, the return of volatility to Asian markets that we are already beginning to witness should benefit those quality businesses that can deliver through market cycles.

As of March 31, 2021, the securities mentioned comprised the Matthews Asian Growth and Income Fund in the following percentages: Taiwan Semiconductor Manufacturing Co., Ltd., 7.5%; Tata Consultancy Services, Ltd., 1.5%; Techtronic Industries Co., Ltd., 2.2%; Ever Sunshine Lifestyle Services Group, Ltd., 1.5%; Minth Group, Ltd., 1.5%; Midea Group Co., Ltd. A Shares, 1.5%; Coway Co., Ltd., 1.5%; Northern Star Resources, Ltd., 1.0%; Pinduoduo, Inc., Cnv., 0.000%, 12/01/2025, 1.1%; ENN Natural Gas Co., Ltd. A Shares, 1.6%; Topsports International Holdings, Ltd., 1.5%; JD.com, Inc. A Shares, 1.5%; Aristocrat Leisure, Ltd., 1.5%; Hansoh Pharmaceutical Group Co., Ltd., Cnv., 0.000%, 01/22/2026, 1.3%; Cerah Capital, Ltd. (CIMB), 0.000%, Cnv., 08/08/2024, 1.2%.

The Fund held no positions in China Resources Land, CLP Holdings, China Yangtze Power, Singapore Telecommunications Limited (Singtel), Hanon Systems, Vinamilk, Baozun Inc., convertible bond. Alibaba Group Holding Ltd, Nike, Inc., or Adidas AG.  Current and future portfolio holdings are subject to change and risk.

Average Annual Total Returns - MACSX as of 03/31/2021