Dear Fellow Shareholders,
How has the recent bear market affected our investment views for Asia? Do we need to change our strategy? Are there opportunities we can seize after the market falls? These questions naturally spring to investors’ minds at times like this. The third quarter was a horrible one for the absolute performance of the Funds; all, with the exception of Japan, recording double-digit declines. Yet, we take some comfort in the fact that most of our Funds have continued to outperform their respective benchmarks. As long-term investors, we tend not to place too much emphasis on managing the short-term volatility of the Funds in a day-to-day fashion. We place more emphasis on investing in the businesses and securities that we believe can best weather these sudden, painful draw-downs caused by investors with shorter-term goals. We try always to be prepared for such events even though it may not be apparent in normal times. That is why I feel some satisfaction that the Funds have, for the most part, performed in the way that we would expect and hope, given the market environment. It is also why we adhere to our long-run strategy, though we are indeed excited by the prospect of finding new opportunities for investment as others sell in fear.
The fall in markets over the quarter has been due to various factors: first, Europe’s sovereign debt problems have been the proximate catalyst. These factors have created a consensus that Greece will indeed default, and have raised the specter of crises in Spain, Ireland and Italy—and even the potential dismemberment of the Eurozone. Secondly, compounding these issues, has been a renewed slowdown of the economies of Europe and the U.S. There are policies to deal with all of these issues—boosting demand via fiscal and monetary stimulus and shoring up confidence in the Eurozone via issues of bonds backed by the stronger members. However, disagreements over what to do and political posturing ahead of elections has put policy in limbo. Uncertainty creates fear; markets fall. Most of the issues that Asian markets are dealing with, therefore, are not of their own making. Is Asia the baby being thrown out with the bathwater?
I believe the answer is that Asia’s treatment at the hands of global investors may be a little excessive, but is not entirely unfair. After all, Asia came through its own crisis in 1997–98 understanding that it needed to do more to develop its own domestic capital markets—particularly bond markets—but has taken only small steps in that direction. It has been slow, too, to build the kind of regional organizations that would have a mandate to quickly step in to backstop any funding crisis. China, obviously, has huge foreign exchange reserves—and people are even speculating about Europeans coming to China for a bailout—but should Asia, first of all, not have a way to save itself? As far as I can see, there is no set of agreements in place that describe who will take action when the next crisis hits. The upshot is that U.S. and European-based investors play a much larger role in Asia’s local bond and equity markets than need be the case. When trouble strikes at home, they liquidate what (to them) are peripheral portfolios in the attempt to raise cash. Asia’s currencies, bond markets and stock markets are vulnerable as a result. The fear rippling over from Europe also comes at a time when Asian countries are stepping on the monetary brakes, trying to rein in a near-term rise in inflation caused by booming demand and credit creation.
On the other hand, yes, Asia’s growth prospects are much brighter than those in the West. They are brighter because Asia has shown itself capable of growing productivity at faster rates of growth than any other region of the world. This is partly because they are starting from a lower base. But it is also because they have put in place enough of the right kinds of institutions and market incentives to encourage profitable growth. All of this has been achieved as the economies of Asia have deleveraged since the 1997 Asian Financial Crisis, which suggests that they have room to continue to produce more goods and services more efficiently and drive domestic demand and corporate profitability.In addition, investors can access such growth
at valuations that, though higher than those available in Europe, are cheaper than U.S. valuations in terms of dividend yield, price-to-earnings and price-to-book ratios. Indeed, it was the recognition of these facts that enabled Asia to emerge more quickly and strongly out of the crisis in 2008.
Our strategy is to try to tap into these sources of growth. A significant part of the relative performance of our Funds has been our focus on buying businesses for the long term—trying to identify those corporations that grow core earnings or dividends at a reasonable rate and with greater certainty over extended periods of time. It is precisely these kinds of companies that are able to attract support in the market, when the world is trapped like a deer in the headlights by fear and uncertainty. These kinds of opportunities remain a focus for the Funds. We will not change our stock selection strategy just because of the dislocation in the markets, but we will look more closely at those opportunities that we may have passed over previously because valuations appeared too high. So shareholders should not expect any change in the strategies of the Funds, but there may be increased activity if and when we are able to identify new opportunities.
Asia’s markets began the year with some growth prospects but valuations that offered no protection against bad news. The events of the last quarter have simply brought into greater relief the risks that we already knew the global economy was facing. Thus, Asia’s markets appear to be starting the final quarter of the year with still solid, long-run growth prospects, but at valuations that are much cheaper and are cheap because investors are now more nearsighted than they were in January. Today’s problems have become the focus of analysis and commentary; tomorrow’s opportunities seem to have slipped from view.
As always, we are privileged to serve as your investment advisor.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC