For the first half of 2023, the Matthews China Dividend Fund returned -8.79% (Investor Class) and -8.70% (Institutional Class), while its benchmark, the MSCI China Index, returned -5.39% over the same period. For the quarter ending June 30, 2023, the Fund returned -11.33% (Investor Class) and -11.24% (Institutional Class), while the benchmark returned -9.65%.

Market Environment:

Chinese equities performed sluggishly in the first half after the post-zero-COVID reopening rally fizzled out in February as consumption data in the period disappointed the market. During the second-quarter holiday festivals of Qing Ming in April, May Day and Duan Wu in June, there was surging demand for travel, and tourist numbers and hotel room rates recovered back to pre-COVID levels. However, spending during the periods remained below pre-COVID levels indicating that Chinese consumers lacked the confidence to spend.

The real estate market is also creating worries as new home sales shrank during the first six months of the year. This has generated calls for the government to further relax the cooling measures it put in place toward the end of the sector’s almost 20-year-long boom. Chinese equities rallied a number of times in the first half on speculation the government was considering certain stimulus policies. However, we think there is limited room to ease monetary policy as the U.S. economy continues to defy the risk of recession. China’s central bank cannot cut interest rates too aggressively as that could create further depreciation pressure on an already weakened Chinese renminbi. A cheap renminbi is good for China’s exports but not for encouraging inward capital flows.  

In addition to China’s uneven recovery, the impact of geopolitical tensions was also present, as the U.S. further tightened restrictions on exports to China of key semiconductor manufacturing equipment and materials.

Performance Contributors and Detractors:

At the sector level, stock selection in IT, communication services and consumer staples were the biggest contributors to relative performance. On the other hand, our overweight and stock selection in real estate was the biggest detractor—and we are revaluating our positions and allocation in the sector. Our underweight and stock selection in financials and stock selection in industrials also detracted.  

At the holdings level, CITIC Telecom was the top performer in the first half. The Macau telecom operator has a stable local business while the returning mainland tourists provide a rebound of roaming revenue. Yadea Group was the second-best performer. We have confidence in the prospects of the electric scooter manufacturer which is developing sodium-ion battery to help solidify its market leadership position. Tencent was the third-best performer. The internet platform reported better-than-expected earnings and management has said it is confident that all its units will recover strongly in 2023. The 50% increase in its annual dividend payment also shows confidence in its financial strength. However, Tencent’s largest shareholder’s plan to further divest shares will create more volatility for the stock.

In contrast, China’s largest duty-free shopping operator China Tourism Group Duty Free, and Hainan Meilan International Airport, which also has significant exposure to duty-free shopping revenue, were among the bottom performers in the period. As Chinese tourists can now go outside the border, Hainan has lost its monopoly status in duty-free shopping. In addition, Chinese consumers are spending less on discretionary items such as cosmetics. We are evaluating the situation carefully.

Notable Portfolio Changes:

During the second quarter, we initiated a new position in the Hong Kong shares of CSC Financial, a brokerage house and investment bank more commonly known as China Securities. The firm, which is less well-known among foreign investors, has been consistently ranked among the top three domestic brokers, especially in terms of securities underwriting. We believe it will benefit from new capital market reforms and its valuation on a price-to-earnings (P/E) ratio basis and discount to its mainland-listed A-shares are very attractive.

We have exited our position in Meituan as the company is facing new competition from ByteDance and is also entering new markets such as Hong Kong. These competitive threats and new investment will make Meituan less likely to achieve near-term profitability, which was our original expectation. In addition, we also exited Hainan Meilan International Airport, as the recovery of both of its traffic and duty-free business is proving challenging.

Outlook:  

While we share some near-term concern over the Chinese economy with many observers, such as unemployment of young people and private enterprises’ low appetite for expansion, we continue to believe the elements of the country’s economic success are still in place. And the current market valuation of Chinese equities is not reflecting an economic revival—many Chinese consumer company shares, for example, have plunged back to last October’s levels. We continue to believe therefore that holding high-quality Chinese companies has the potential to offer very attractive rewards for investors over the long term.

Price-to-earnings (P/E) ratio: Is a valuation ratio of a company's current share price compared to its per-share earnings.

Top 10 holdings as of June 30, 2023. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MCDFX as of 06/30/2023