For the quarter ending March 31, 2023, the Matthews Korea Fund returned 5.76% (Investor Class) and 5.70% (Institutional Class), while its benchmark, the Korea Composite Stock Price Index (KOSPI), returned 7.28% over the same period.

Market Environment:

The first quarter was quite volatile—particularly as investors were initially quite enthused about China’s reopening and recovery but simultaneously wrestled with several sector-level issues and concerns. Korean equities outperformed regional peers as investor expectations for the batteries and memory markets improved. The country’s auto market has also done nicely, contributing to market returns.

In addition, we are increasingly seeing enhancements among Korean companies to their dividend and shareholder return policies as they act on changes suggested by management teams. For example, a growing number of large corporations are canceling treasury shares and increasing returns to shareholders in terms of their dividend payout ratios—both positives, in our view. Further, such changes are increasingly becoming an annual practice—a trend we hope will continue.

Performance Contributors and Detractors:

At the sector level, our underweight in materials was among the biggest detractors to relative performance in the first quarter. We have maintained our underweight because materials businesses tend to be highly cyclical. However, many materials companies in the period were driven by electric vehicle (EV) battery exposure—hence, our below-benchmark exposure was a headwind.

Conversely, we benefited from our underweight to financials. While we see opportunities for shareholder returns to improve in Korean financials, we also note earnings in the sector have been good for many years. Given ongoing macroeconomic uncertainties, we didn’t want to increase our exposure to the sector at this point—though should valuations become interesting, we would consider increasing our weighting.

At the holdings level, Leeno Industrial and S-Oil were among our bottom contributors. Leeno Industrial, a leading manufacturer of testing components for integrated circuit (IC) production, has been a key portfolio holding for many years. In the first quarter, Leeno’s shares were pressured amid concerns that customers may lower inventory levels in the period ahead. However, we believe Leeno will remain an important partner for the customers to innovate with, and we maintain our conviction in its outlook.

Shares of S-Oil, a Korean refinery, were pressured in the period in sympathy with volatile oil prices. However, structurally, the global refinery business is in short supply and S-Oil has a solid track record of operating its assets effectively and reinvesting cash flow into its downstream businesses. At its current valuation, we think the outlook for the company is positive and are maintaining our position.

Conversely, Samsung SDI and Samsung Engineering were among our top contributors. Samsung SDI is a manufacturer of battery cells. The company has successfully improved profitability and expanded its customer base. As the U.S. attempts to incentivize EV penetration via legislation like the Inflation Reduction Act, Samsung SDI is well-positioned to benefit and diversify customers, in our view.

Samsung Engineering is an EPC (engineering, procurement and construction) contractor for hydrocarbon projects and an industrial plant builder. As oil prices have risen, demand for Samsung Engineering’s services has increased as clients—particularly in the Middle East—seek to expand their capacity in petrochemical, refinery and gas projects. Samsung Engineering is also the key builder for other Samsung group companies—including Samsung SDI, Biologics and Electronics—which provide captive orders. We believe the outlook for orders and the order backlog, as well as profitability, is solid.

Notable Portfolio Changes:

During the quarter, we initiated a new position in Korea Zinc, a global leader in the smelting business for non-steel and precious metals. Its best-in-class smelting capabilities, with fumer technology, results in a high recovery rate and free metals for the company. Korea Zinc has been expanding its footprint to copper by building a recycling ecosystem. We appreciate the company’s free cash flow-generation capabilities and believe the outlook for the stock is positive. 

Conversely, we exited our position in long-time holding NCSoft. While we value the online game publisher’s strong intellectual property, we think expectations for the new titles pipeline is largely reflected in the current share price and consequently chose to conclude our investment.

Outlook:

As we look forward, we are being conscious of valuations in some areas. For example, we think valuations for battery value chains are demanding so we want to avoid indiscriminately buying and thereby risking our ability to generate a positive long-term return. Further, with many battery makers expanding their footprints outside the U.S. and Korea, we want to measure the risks of operating in a new area before buying into those opportunities.

We are currently overweight in information technology as we believe many negatives around the memory business have already played out—both overall and at the individual stock level. We continue to find companies which we think can grow in Korea in terms of equipment and R&D processes within the memory and semiconductor business. As a result, many of our research efforts have been directed to those areas.

Elsewhere, we think valuations in the consumer names (both discretionary and staples) are looking more interesting as overall market performance has been driven by battery names and cyclicals year to date. That introduces some interesting investment possibilities in relatively ignored areas of the market, like the consumer-related ones.

As always, we will maintain our diligent, rigorous approach to fundamental research and will capitalize on appealing investing opportunities we uncover as the year unfolds.

Top 10 holdings as of March 31, 2023. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MAKOX as of 03/31/2023