For the third quarter ended September 30, 2022, the Matthews Emerging Markets Equity Fund returned -6.02% (Investor Class) and -6.01% (Institutional Class), while its benchmark, the MSCI Emerging Markets Index, returned -11.42%.

Market Environment:

Asset markets including equities remained spooked with heightened volatility and uncertainty in the third quarter. As inflation stayed elevated, markets broadly priced in tighter monetary policy and the U.S. 10-year yield approached 4%. The U.S. dollar remains exceptionally strong; a phenomenon that is more pronounced in G10 currencies like the Japanese yen and British pound than in emerging markets. Meanwhile, China’s path out of its zero-COVID policy and the direction that the country’s economic reopening will take is uncertain. In addition, geopolitics continue to weigh on sentiment as Russia’s war with Ukraine appears to be intensifying. East Asia is also at the center of tensions in a way that it hasn’t been for a long time. Industrial policies like the U.S. CHIPS and Science Act, which encourages the domestic production of semiconductors, are indicative of the strain in the status quo economic system.

Performance Contributors and Detractors:

From a regional perspective, our underweight and stock selection in China was the biggest contributor to relative performance as Chinese equities generally were impacted by the country’s COVID lockdown policy and geopolitical tensions with the West. Our overweight and stock selections in Brazil and Mexico were also significant contributors to performance. Conversely, our stock selection in India was a big detractor to relative performance as certain financial holdings lagged other sectors. 

At the sector level, higher inflation and higher interest rates drove us to lighten our consumer discretionary exposure. Our underweight and stock selection in the sector was the biggest contributor to relative performance. Our stock selections in financials and in information technology (IT) were also top contributors. On the other hand, our lack of exposure to utilities was the biggest detractor.

At the holdings level, two of the top four contributors were Brazilian: Petroleo Brasileiro in the energy space and Hapvida Participacoes e Investimentos in health care. This is notable as energy is generally a globally oriented industry whereas health care tends to have a domestic skew. But Brazil’s markets have been among the most resilient of emerging markets this year. Petroleo Brasileiro, or Petrobras as it’s more commonly known, has benefited from surging oil prices. Hapvida has a large structural opportunity in entry-level private health insurance, which is underpenetrated in Brazil. Among the top 12 contributors to return, five were financials across India, Mexico, Brazil and Indonesia. The commonality being that higher rates tend to increase profits for financial companies and accessible valuations in this sector have held up well compared to more conceptual growth narratives in other areas. On the flip side, Tencent was the largest detractor. The company, which has been impacted  by China’s economic woes and challenging regulatory backdrop, continues to simplify its structure which we think will work to unlock value although sentiment remains quite weak around the name. Samsung and TMSC were also big detractors amid a softening of global demand for semiconductors and heightened geopolitical tensions encircling the industry.

Notable Portfolio Changes:

The Fund remained quite active in the quarter with much of our moves driven by new ideas. We continue to be positively disposed toward Vietnam and initiated a position in HD Bank to complement our other holdings in the country. We also started a small position in Kaspi.kz, a leading internet and fintech player in Central Asia. Weak markets provided some avenues to minimize capital gains which was the primary reason we sold Ayala Land, a real estate company in the Philippines, and bought Ayala Corp. These separate holdings are closely correlated as Ayala Land is the biggest portion of Ayala Corp. which is a larger company with additional holdings. During the quarter we also exited our position in Heineken as we moved to lighten our consumer exposure.

Outlook:

Global market sentiment is being driven in large part by macro and geo-political influences. Few regions and sectors are immune and these influences are creating conflicting signals and volatility that are muddying the waters for investors. What we advocate, and we are pursuing, is what we consider to be a cautious approach. Our focus remains resolutely on companies that have attributes that should allow them to weather tough times. We look for best of breed companies with solid balance sheets at understandable valuations. The portfolio trades at multiples similar to the index but with higher capital efficiency ratios, solid returns to shareholders in the form of buybacks and dividends, and generally less leverage.

While markets remain challenging, they also provide opportunities, often away from the benchmark. Quality companies with growth characteristics tend to exhibit the same attributes irrespective of where they are located or what industry they operate in. It’s these attributes that lead us to identify long-term opportunities even in difficult times.

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

Average Annual Total Returns - MEGMX as of 09/30/2022