For the first half of 2022, the Matthews Emerging Markets Equity Fund returned -24.69% (Investor Class) and -24.55% (Institutional Class), while its benchmark, the MSCI Emerging Markets Index, returned -17.47% over the same period. For the quarter ending June 30, 2022, the Fund returned -14.96% (Investor Class) and -14.80% (Institutional Class), while the benchmark returned -11.34%.

Market Environment:

The first half of 2022 was the weakest start for the S&P 500 since World War Two with the exception of 1962 when markets were upended in the months leading up to the Cuban Missile Crisis. The NASDAQ Composite Index is down around 30% for the first half of the year. Elsewhere, bonds, crypto assets and cash provided little succor making the year thus far one of the most confounding of my career.

There have been some bright spots. Broadly, U.S.-listed Chinese American Depositary Receipts (ADRs) had their best month in June in three years after regaining from some of the underperformance of recent quarters. But while there are exceptions at the company level, index estimates indicate investors are still paying a hefty price-to-earnings ratio (P/E) premium for U.S.-listed China exposure, with the NASDAQ Composite Index trading on 23-24x 2022 earnings and the NASDAQ Golden Dragon China Index trading on 33-34x earnings.

With U.S. Federal Reserve rates likely to move higher and little abatement in geopolitical tensions, the prospect of pandemic stocks roaring back and China internet stocks rebounding meaningfully is not a given. There is still very much a case for selectivity—and balance, ballast and income are worth considering too.

Performance Contributors and Detractors:

From a regional perspective most of our relative underperformance in the first half of the year was tied to Russia, which is nominally marked at close to zero. The pain has been taken. Geopolitical events on the magnitude of the invasion of Ukraine are rare, hard to predict ex-ante but easy to Monday morning quarterback. Our overall construction held up well in what was a major geopolitical event. That’s in stark contrast to strategies that underperformed as a result of an inability to pivot from early-stage companies with little profits that were en vogue during the pandemic and now face material headwinds in the current market backdrop. On the other hand, our allocation to Vietnam contributed the most to relative performance in the first half.

At the sector level, our overweight and stock allocation in real estate contributed the most to performance over the past six months while stock selection in materials was a positive contributor. In contrast, our stock selections in energy and financials detracted the most.

At the holdings level, real estate company CapitaLand Investment in Singapore was a top contributor in the first half, as was energy giant Petroleo Brasileiro SA in Brazil and financial services company AIA Group in Hong Kong. Two information technology (IT) stocks: Samsung Electronics Co. Ltd Pfd and Taiwan Semiconductor Manufacturing Co. (TSMC) were among the biggest detractors. The semiconductor space has been weak as fears of a recession or global slowdown weigh on sentiment. Samsung and TSMC fit our framework well as both have exceptional competitive positions, strong cash generation, and balance sheets that allow for funding of expansion from internal resources. These companies should continue to benefit long term from more chips in more things as well as from an expansion of semiconductor fabs in different geographies.

Notable Portfolio Changes:

Among the holdings we closed in the second quarter was our position in Alibaba Group Holding Ltd. The business is cheap, but we are unsure of the go-forward prospects in both its core e-commerce business and its capital allocation outside of it. Among the positions we added are Prudential Plc, which has a large, successful Asian life insurance business that is growing new business volumes in most of its markets now and should benefit meaningfully from re-opening in Hong Kong and China, the timing of which remains uncertain.

Outlook:

We’ve attempted to re-evaluate each of our holdings to understand resiliency against a backdrop of persistent (but perhaps peaked) inflation, geopolitical tension, and bias toward higher U.S. rates, which puts comparatively more pressure on cashless narratives compared with cash-generating ones. A strong dollar is a topic we’ve touched on in the past. The depth of asset price declines appears indiscriminate at times. When the dust settles, we believe elements of our framework including capital allocation, cash flow and capital structure, combined with solid company character, will eventually gain traction.

Good things tend to take care of themselves so investors need to ask hard questions about how companies will perform if the backdrop remains challenging. A U.S. recession or general decline in economic activity is increasingly a topic of concern. We don’t have any unique insight on the probability or depth of a slowdown, which is why the Matthews Emerging Markets Equity Fund remains more cautiously positioned than in past quarters. We believe investors need to think beyond consumer-driven trends that dominated during the height of the pandemic and embrace a broader set of companies going forward.

Top 10 holdings as of June 30, 2022. Current and future holdings are subject to change and risk.

Definitions:

NASDAQ Composite Index: A market capitalization-weighted index of over 3,700 stocks listed on the Nasdaq stock exchange, heavily weighted toward the technology sector.

NASDAQ Golden Dragon China Index: A modified market capitalization-weighted index featuring companies whose common stock is publicly traded in the U.S. while the bulk of their business is conducted in China. 

Average Annual Total Returns - MEGMX as of 06/30/2022