For the first half of 2023, the Matthews Asia Growth Fund returned -1.01% (Investor Class) and -0.95% (Institutional Class), while its benchmark, the MSCI All Country Asia Pacific Index, returned 6.35% over the same period. For the quarter ending June 30, 2023, the Fund returned -3.69% (Investor Class) and -3.64% (Institutional Class), while the benchmark returned 1.43%.

Market Environment:

The story of 2023’s first half has inarguably been about China. The year started on a positive note as markets anticipated that China’s lifting of zero-COVID would meaningfully boost economic activity—but the anticipation quickly faded as China’s economy struggled to regain its footing and domestic sentiment proved a meaningful drag. Consequently, China’s market returns have been negative year-to-date. Further weighing on China’s macro picture has been the property market, which has contributed to dour sentiment as many Chinese hold their wealth via real estate. Property market downturns make many Chinese citizens feel relatively poorer which decreases the likelihood they will spend money and help the economy.

Beyond China’s shores, the macroeconomic picture hasn’t been much better with much of the West (notably the U.S. and Europe) still battling inflation—an extended effort that has resulted in notably higher interest rates. If there is a bright spot, it may be Japan where the markets are improving thanks to fundamentals which appear to be turning for the first time in several decades. Spurred on by the Tokyo Stock Exchange, Japan-domiciled companies are finally working to improve their price-to-book ratios via share buybacks. Many Japanese companies have also increased their dividend payout ratios, improving their value to shareholders. In our view, these changes are meaningful and substantive and we believe Japan may be at the beginning of long-needed structural change. Another market offering encouragement has been India, which is benefiting in part from moves by some companies to make their supply chains less dependent on China.

Performance Contributors and Detractors:

Regionally, our overweight and stock selection in China was the biggest detractor to relative performance in the first half of the year. Our underweight to Taiwan—a relative bright spot given ongoing geopolitical tensions around the semiconductor industry—was also a large detractor. Our holdings in Japan, while positive on an absolute basis, trailed the benchmark and detracted from performance. On the flip side, our stock selection in Indonesia and our overweight to India were strong contributors to performance.

At the sector level, relative weakness was concentrated in our health care exposure—which detracted from performance due to our overweight position and stock selections. Our selections in consumer discretionary and industrials, and our underweight in IT also detracted. Conversely, our stock selections in financials were a source of relative strength, as were our materials holdings.

At the individual holdings level, JD.com and InnoCare Pharma were among our bottom contributors in the first half. Chinese e-commerce giant JD.com suffered as Chinese consumers were slow to increase consumption in the wake of zero-COVID’s lifting. Though many investors have seemingly soured on the outlook, we maintain our conviction in the company’s quality and are attracted to its solid balance sheet with ample cash. Shares of China-based InnoCare Pharma declined sharply following the company’s announcement that its exclusive global licensing (ex-China) agreement with the U.S.’s Biogen to develop and market a BTK inhibitor for multiple sclerosis had been discontinued. As a result, we exited our position.

Among our top individual contributors were Legend Biotech and Shin-Etsu Chemical. China-based biopharmaceutical Legend Biotech has developed arguably a best-in-class CAR T-cell therapy for cancer—an area with few competitors. Given the company’s solid fundamentals, we like the outlook from here and its positioning in the space. Shares of Shin-Etsu Chemical, a premier Japanese semiconductor wafer company with large global market share, rose on the back of strength in semiconductor stocks. We favor the company’s solid fundamentals despite its exposure to the U.S. housing market as a dominant PVC maker. 

Notable Portfolio Changes:

During the last quarter, we initiated positions in Toyota and Mahindra & Mahindra. Japanese automaker Toyota has solid fundamentals, a long history as one of Japan’s premier companies and is exposed to the ongoing transition to electric vehicles (EVs). Similarly, Mahindra & Mahindra is an India-based automaker specializing in SUVs—a growing vehicle category in India which we expect to boost the company’s sales in the period ahead.

In addition to exiting InnoCare Pharma, we sold our positions in Taiwanese power management chip company Silergy and long-time holding Vietnam Dairy Products following conversations with both companies’ management teams which weakened our confidence in their outlooks. We opted to redeploy our capital into more compelling opportunities.

Outlook:

We don’t have a crystal ball that can tell us what will happen in China, which continues to be the primary concern. Many have called a bottom several times in China’s market only to see it decline further. It’s hard to see much of a reason for sentiment in China to shift meaningfully in the near term. The likelihood the government can effect a quick turnaround seems low.  We think, however, that an uptick in IPOs in the Hong Kong market should encourage global investors to participate in the market in the next three to six months.

Elsewhere, we are encouraged by the progress we’re seeing in Japan and expect it to continue along its current structural change path. Compounding our enthusiasm are valuations which, though certainly higher in the wake of the recent market rally, remain relatively cheap, in our view. By way of contrast, India, which also remains a relative bright spot, has much higher, and consequently less attractive, valuations. As we’ve gained confidence in Japan and its companies’ fundamentals, we’ve decreased our exposure to China while increasing our Japan holdings. 

Over the next six months, we would like to think sentiment will gradually improve—and that perhaps the rate-hike cycle will conclude in the West and markets will find more reasons to continue climbing the proverbial wall of worry. We will certainly watch with interest and are prepared to position the portfolio accordingly as events unfold.

View the Fund’s Top 10 holdings as of June 30, 2023. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MPACX as of 06/30/2023