For the quarter ending March 31, 2023, the Matthews Emerging Markets Sustainable Future Fund returned 1.28% (Investor Class) and 1.36% (Institutional Class), while its benchmark, the MSCI Emerging Markets Index, returned 4.02%.

Market Environment:

2023 started where 2022 ended with the market closely following inflation data releases and trying to assess the U.S. Federal Reserve’s reaction function to them. After doing well in the first few weeks of 2023, on account of a belief that inflation might be softening, the markets had a reality check in February after a worse than expected inflation data print. Silicon Valley Bank’s collapse, followed by troubles at Signature Bank and First Republic Bank, led to a bout of risk-off sentiment and challenges for equity markets in addition to tightening financial conditions toward the end of the quarter.

Select Latin American currencies did well again against the U.S. dollar after a strong 2022 performance. The Mexican peso, Chilean peso, Colombian peso and Brazilian real appreciated the most among emerging markets currencies alongside the Hungarian forint during the quarter. The Argentine peso and Turkish lira, 2022’s worst performers, continued to depreciate against the U.S. dollar as did the Russian ruble and South African rand.

For the quarter, the Czech Republic, Mexico, Greece and Taiwan were the best performing markets. Colombia, Turkey, United Arab Emirates (UAE) and Singapore were the worst performing markets. A number of the poor performers in 2022 turned in strong performances during the quarter, including South Korea and Taiwan. From a sector perspective, information technology (IT) and communication services were the best performers while utilities was the worst performer.

Performance Contributors and Detractors:

On a country basis, our stock selection in South Korea was the biggest contributor to relative performance during the quarter while our stock selection in China/Hong Kong and overweight and stock selection in India were the biggest detractors.

From a sector perspective, our stock selection in industrials, IT and health care contributed positively to relative performance. On the flip side, our stock selection in financials, consumer discretionary and consumer staples were the biggest detractors and our underweight and stock selection in communication services also hurt performance.

At the stock level, South Korean battery supply names in the portfolio including Ecopro BM contributed positively to performance. After having underperformed toward the end of 2022 on worries over weak demand and oversupply concerns, many of these names rebounded strongly in the first quarter on the back of positive news flow over the potential impact on electric vehicle demand and customer eligibility for IRA subsidy payments of the U.S. Inflation Reduction Act. Strong new customer order wins, especially from U.S. automakers alongside capacity addition announcements, also contributed to strong performance by these stocks.

In contrast, Indian financials such as Bandhan Bank and Shriram Finance detracted from performance amid a general decline in Indian equities after their strong performance in recent years left relative valuations very expensive, especially compared with China. Indian financials also got caught up in the global financials selloff in the aftermath of turbulence in the U.S. financial system following Silicon Valley Bank’s demise. Our lack of exposure to large Chinese platform technology names like Tencent, which have business models we have deemed challenging from a sustainability perspective, was also a drag on returns in the quarter.

Notable Portfolio Changes:

In 2023, we initiated a position in Brazilian fintech company Nu Holdings. Nu is a global fintech leader with over 70 million customers across Latin America, most of whom are in Brazil. Nu has disrupted the Brazilian banking sector by providing transparent and convenient digital services to underserved customers in a market where interest rates on consumer products are exceedingly high. Nu already serves 44% of Brazil’s population despite being only a decade old and is the primary banking platform for over 58% of its customers. Nu’s competitiveness is further enhanced by low cost of customer acquisitions and operations. It has also entered Mexican and Colombian markets in the recent years where it serves less than 5% of the adult population thereby providing a potentially long growth opportunity.

During the first quarter, we exited positions, including Lemon Tree Hotels, an Indian hotel chain, after a strong run by the stock. We also exited Bank Tabungan Negara, an Indonesian mortgage lender, as we found more attractive opportunities elsewhere.

Outlook:

The Fed’s interest rate strategy and the market’s expectation of its evolution remain the most important variables impacting the near-term performance in emerging markets. That said, we expect the impact of the Fed’s actions this year to be less than it was in 2022 as the tightening cycle enters the late stages.

Our other key focus will be how China’s economic recovery and growth plays out and how it affects the dynamics of other emerging markets. And Russia’s invasion of Ukraine and its effect on energy prices— alongside OPEC’s efforts to keep the prices high—will need ongoing, careful monitoring.

Over the coming years, we expect the emerging markets gross domestic product (GDP) growth-differential with developed markets to improve from a 23-year low reached in 2022. This development, alongside relatively attractive valuations, should potentially lend support to better equity performance against developed markets compared with the last decade.

Companies that address critical challenges, such as climate change and inclusive development, will continue to thrive, in our view. And for investors interested in sustainability themes, including reducing carbon emissions, alleviating poverty and creating greater financial inclusion in the developing world, emerging markets remains a key investment destination. We believe there are attractive opportunities for alpha generation throughout our large, diverse, sustainable investment universe.

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

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