For the quarter ending September 30, 2021, the Matthews Asian Growth and Income Fund returned -6.10% (Investor Class) and -6.11% (Institutional Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned -9.23% over the same period.

Market Environment:

Asian markets struggled during the third quarter as a number of factors weighed on sentiment. At a broad level, risks to growth became more apparent as a combination of the rise of the COVID-19 Delta variant alongside restrictive COVID policies by many governments hurt economic activity, while there were also concerns of the impact of rising inflation. In addition, further regulatory clampdowns in China as well as the drive toward “common prosperity,” which has impacted sectors from property to communication services, have led China to be the region’s worst-performing market during the quarter, falling over 15% and the majority of equity markets across Asia fell. Domestic demand-oriented India was an exception as the market gained double digits amidst solid liquidity, a low base effect for earnings and the relaxation of COVID-related restrictions.

Performance Contributors and Detractors:

The largest contributor to the Fund’s absolute performance was Taiwanese financial company Chailease Holdings. The leasing company has delivered stellar growth with recent earnings increasing by over 30% compared to last year as it enjoys a combination of growing assets, rising loan spreads and benign asset growth. Similarly within financials, India’s leading mortgage financier Housing Development Finance Corp gained as it has again displayed superior asset quality during the pandemic, enhanced its cost of funding through this period, and is now enjoying strong portfolio growth. This has been driven by low mortgage rates and an increase in the affordability of India’s housing stock. Beyond these, Hong Kong-based Techtronic Industries, the global leader in power tools was a significant contributor to returns. The stock gained as it delivered earnings growth of over 50% in the first half. Techtronic has been growing its market share with the migration to cordless tools, extending into categories such as outdoor, and is a potential beneficiary of U.S. infrastructure spending.

The portfolio’s ongoing underweight within the Chinese internet sector also helped relative performance as major benchmark constituents that we do not hold, such as Alibaba, declined due to further regulations and weakening consumer sentiment. Despite this, the largest detractor to the Fund’s absolute return was Tencent Holdings. The leading social network and games company in China fell on further regulation restricting the amount of time younger players can use its games, as well as pledging over US$7 billion for China’s “common prosperity” goals. Chinese consumer discretionary stocks Topsports International Holdings and Minth Group also fell. The former is the country’s largest Nike retailer and has been under pressure as sales of Nike goods have sputtered following its comments regarding the use of Xinjiang cotton and the growth of domestic Chinese sportswear brands. Minth Group, a leading auto parts manufacturer dipped as chip shortages continue to impact its OEM (original equipment manufacturer) customers while increased raw material and shipping costs compress margins. 

Notable Portfolio Changes:

Our portfolio activity was relatively light during the quarter, adding two new Chinese holdings in Wuliangye Yibin and a convertible bond of Weimob. Chinese baijiu company Wuliangye is a leader within the premium spirits sector in China, giving it pricing power in a growing sector. Additionally, we believe that double-digit growth can be driven by various sub-brands as well as through an increase in direct sales, which should be able to generate further margin expansion. The business is also attractively valued at 20x EV/EBITDA, offers a 1.7% dividend yield, and has a balance sheet with significant amounts of net cash. Weimob is a software-as-a-service (SaaS) company that offers its customers a value proposition of helping retailers with their digital transformation and full access to their own data, as e-commerce becomes more de-centralized. We believe Weimob can grow its earnings substantially through rising subscribers and revenue per user as customers upgrade. The convertible bond had an appealing risk/reward skew, with a yield of 4.8% and trading near its bond floor, while still offering a healthy upside participation in the stock in our view.

In order to fund these changes, we exited our holdings in two Chinese convertible bonds. These were in e-commerce platform Pinduoduo and pharmaceutical company Hansoh.

Outlook:

The strength of equity markets across the globe since March 2020—driven by an unparalleled level of monetary and fiscal stimulus—now appears to be somewhat under threat. Inflation and whether it will be transitory or persistent, and what that means for future rate hikes and the withdrawal of quantitative easing, remains a critical ongoing issue. To us, it appears that the rise in energy and labor costs, alongside supply chain issues, may create at least some degree of more sustained inflationary pressure. Added to potential monetary tightening is the question of whether incremental fiscal support will be as expected as Democrats continue to battle over the scale of the Build Back Better plan. To an extent, these pressures can be offset by a greater return to normalcy as vaccination rates tick higher across the globe and as the Delta variant wave appears, at least for now, to be waning.

Turning to Asia, policy risks are also present. These are less on the monetary and fiscal side as policy here remains more “normal” and growth potential more secular. However, increasing regulation and the move by President Xi in China toward “common prosperity” has had significant ramifications to certain businesses including those within the education, property, financial and internet sectors. It is no surprise that the country has lagged the equity markets of other countries in the region over the last few months as the economics of certain business models have been disrupted. Added to this have been challenges in the property sector given the large liabilities and potential restructure of highly indebted China Evergrande Group.

If the global policy landscape is volatile, it is difficult to take meaningful comfort from valuations while earnings estimate trends also appear to be losing some steam. The former remain elevated almost everywhere, although it should be noted that, in this regard, China does look attractive compared to other major equity markets.

The current environment of policy risk, a tougher backdrop for positive growth surprises and elevated valuations leads us to believe that prospective returns may be more challenging and volatile. We are, however, constructive that parts of the Asian equity markets remain attractive and that the portfolio is set up to take advantage of these opportunities. Our focus remains on identifying those high-quality compounders that are less susceptible to the whims of policymakers and inflation trends, aiming to buy those businesses that strike a healthy balance between both growth and income.

As of September 30, 2021, the securities mentioned comprised the Matthews Asian Growth and Income Fund in the following percentages: Chailease Holding Co., Ltd., 1.3%, Housing Development Finance Corp, 2.6%; Techtronic Industries Co., Ltd., 1.8%; Tencent Holdings, Ltd., 5.3%; Topsports International Holdings, Ltd., 1.7%; Minth Group, Ltd., 1.5%;  Wuliangye Yibin Co., Ltd. A Shares, 1.3%, Weimob Investment, Ltd., Cnv., 0.000%, 06/07/2026, 1.2%, . The Fund held no positions in Alibaba, Pinduoduo, Hansoh , Nike or China Evergrande Group.

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

Earnings growth is not representative of the fund’s future performance.

Average Annual Total Returns - MACSX as of 09/30/2021