For the year ending December 31, 2022, the Matthews India Fund returned -9.92% (Investor Class) and -9.83% (Institutional Class), while its benchmark, the S&P Bombay Stock Exchange 100 Index, returned -4.53% over the same period. For the fourth quarter, the Fund returned 0.58% (Investor Class) and 0.57% (Institutional Class), while the benchmark returned 3.40%.

Market Environment:

Central banks maintained their war against inflation with higher interest rates globally during 2022. Even though inflation has generally subsided in the past few months, the pace of moderation has been behind the estimations of most. As a consequence, it’s expected that higher rates will be here for longer even as the pace of incremental rate hikes slows.

To complicate this dynamic, we’re also seeing China remove its entrenched zero-COVID restrictions. As activity in the world’s second-largest economic power starts to normalize it will help improve global gross domestic production (GDP) but it’s also likely to exert upward pressure on inflation. Hence, it’s reasonable to assume that central banks are unlikely to start to ease monetary policy anytime soon.

In India, the rupee continues to be range-bound but given the current interest rate policy it remains to be seen if that will stay the case. The differential between central bank rate policy in the U.S. and in India is at its lowest for the last 15 years, which suggests that outflow of dollar reserves from India will remain a risk in a near to medium term and the rupee will continue to be volatile.

Separately, consumption in India continues to moderate. Amid inflationary pressures, consumption is negatively impacted in lower-income sections of the economy. However, we are beginning to see some pick-up in nominal wage growth in rural India along with higher remittance which should help alleviate a cash crunch in non-urban areas of the country.

Performance Contributors and Detractors:

At the sector level, our underweight in energy was the biggest contributor to relative performance in the year as oil marketing firm margins were negatively impacted by the high price of oil. Our overweight to industrials was also a positive contributor to performance as manufacturing activity in India continues to gather pace. On the other hand, our stock selection within consumer staples was the biggest detractor to performance. Stock selection within information technology, consumer discretionary and financials was also a detractor though the negative impact from financials was mitigated to a degree by our overweight position.

In the last quarter, our allocation and stock selection in consumer staples and communication services was the biggest contributor. On the flip side, allocation and stock selection in consumer discretionary was the biggest detractor, impacted by our holdings in the interest rate-sensitive autos segment.

At the holdings level, Lemon Tree Hotels and Cummins India were among the top contributors to performance for the year. Cummins is one of the largest manufacturers of engines globally and within India, it is a leading provider of back-up power generating units. A revival in infrastructure and real estate along with robust exports in India helped the company post robust revenue and earnings growth.

Conversely, Infosys and Tata Consultancy Services were among the biggest detractors and were hurt by softening demand from Western and international clients. Restaurant Brands Asia was also a detractor. While the company continues to grow well and execute on plans for network expansion, high inflation resulted in profit margin-performance being slightly behind investor expectation which negatively impacted performance.

Notable Portfolio Changes:

We continued to consolidate the portfolio and reduce the number of holdings in the Fund in favor of companies which we think are more insulated from external headwinds and where growth expectations are reasonable. To this end, we exited Gujarat Fluorochemicals, a leading producer of fluoropolymers. The company has benefited from higher pricing for many of its manufactured products due to the pandemic restrictions in China but with China reopening we think some of those tailwinds will convert into headwinds. We also exited ABB India. The engineering and construction company continues to do well; however the valuation is very rich and with global GDP slowing down we believe it is prudent to exit.

We initiated a position in Syngene International, a contract research service (CRS) provider. Syngene continues to benefit from greater outsourcing of research projects by big pharma globally. The company also recently got certification from the U.S. Food and Drug Administration (FDA) to commence operations of its biologics manufacturing facility, which would mark the beginning of its custom development and manufacturing operations (CDMO). The CDMO business will help Syngene deliver higher growth and diversify its business model, in our view.

Outlook:

We continue to remain cautious for the near-term outlook. While inflation has peaked and it seems like we are nearing the end of rate tightening globally, we expect rates are going to remain higher for longer and consequently it is going to have a negative impact on demand for goods and services globally. Reduced economic activity globally is going to have a negative impact on exports from India in the near to medium term. Amid low exports and higher rates in the developed world, the rupee may continue to have a depreciation bias unless oil prices decline.

Despite the external headwinds, we think the financial services sector in India continues to be in a very healthy state. Even if we have a slowdown, we don’t expect private and public sector banks to have credit quality challenges which would mean any slowdown would be short lived and would not lead to market panic. Banks, however, are increasing deposit rates and these are becoming attractive from an investment perspective. We think this is likely to pose the biggest risk to markets in India in the near term given the fact that current equity valuations leave little room to absorb negative surprises.

India’s government will also shortly be presenting its budget and since there are general elections next year this event will take on greater importance. There are widespread expectations that the government will announce an increase in spending at the grass roots and rural level where large chunks of the population live. While this would be helpful in improving consumption, a higher-than-normal fiscal deficit will only heighten existing inflationary challenges. Another cause of concern relates to expectations that the government is likely to raise long-term capital gains tax on equity investments from current 10% to 20%. If that were to happen it will likely create negative sentiment in the market at least in the interim.

Top 10 holdings as of December 31, 2022. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MINDX as of 12/31/2022