Semi-Annual 2009 Letter to Shareholders
June 1, 2009
Dear Fellow Shareholders,
To some investors it may appear that everything is back to normal. Long-term treasuries are yielding pretty much what they did before the crisis. Credit spreads on investment grade corporate debt are back to pre-Lehman levels. Core inflation is back down to the 2% level that is assumed to be the U.S. Federal Reserve’s target. The Fed Funds rate is still close to zero, but conditions in the interbank money markets have improved and futures markets are anticipating an ‘exit strategy’ from extreme monetary policy measures. Equity markets, too, are trading close to long-term average valuations.
However, the normality in the financial markets hides much of the uncertainty in the real global economy. Unemployment in the U.S. and Europe is high and rising. Financial systems in the West have stabilized but borrowing and lending are subdued and their stimulus programs are finding it hard to gain traction. China’s economy is growing quickly again but investors worry about non-performing loans and the loss of the U.S. export market and what, if anything, might replace it. Fears of protectionism and changing political relationships cloud the horizon.
Amid the recovery in capital markets that took place in the first half of 2009, the Matthews Asia Funds have on the whole performed well, but did not fully participate in the acute rally in the most risky and distressed securities. Our Funds tend not to hold large positions in such equities as we try to avoid the allure and risks of short-term returns and cyclical stocks. Rather, we seek companies that we believe will benefit from the long-term economic evolution of the region.
One Fixed Point
To deal with uncertainty, it is useful to focus on one fixed point. For us, it is our confidence in the secular growth of the Asian household—in terms of both its rising average wealth and increasing sophistication. Incomes have grown steadily throughout the past three decades—even through the Asian financial crisis. We have seen, for example, wages in East Asian economies (excluding Japan) increase from just 8% of U.S. levels in 1975 to 39% in 2007.
China is a prime example. Twenty years ago life there was an uninspiring struggle. When I was studying in Beijing, my university professor’s compensation consisted of a tiny university room and the equivalent of about US$20 a month—enough for a couple of meals a day. As a result, many academics turned into street vendors at night—I can remember buying lamb kebabs from a university lecturer on the streets of Taiyuan. My Chinese classmates waited for the government to allocate similarly low-paying jobs to them as teachers or in state publishing houses. Years later—as reforms rolled on—I learned my own roommate had quit his job at the publishing house, joined an insurance company, and launched an internet start up. Colloquially, he had “taken the plunge” into China’s new capitalist markets. Now, the Chinese government wants to start the process of privatizing the publishing houses that my former roommate found so uninspiring. What changes in 20 years! Changes I would not have dared imagine. And yet in the 1990s it did seem clear, in a general sense, that economic growth would transform Chinese lives. The particular ways may not be predictable year to year, but the trend, direction and even pace seem set.
Superficially, China has changed a lot. The new China has brought nearly 300 million people from rural to urban life since the 1990s; adding to the urban population at a rate of 1.5 million people each month— roughly the population of Philadelphia. This shift has been significant and obvious to the naked eye. In fact, much of the quaintness of the old Beijing I knew is now gone; replaced by functional, modern buildings. But its quaintness obscured great poverty and now the new buildings incubate great prosperity. As the example of the kebab-selling academic shows, China’s growth has been through the hard work and ingenuity of the Chinese people and not just some abstract offshoot of an “export-driven” economic model. Indeed, net exports only directly contributed 2-3% to China’s 10% growth rate, even as the trade surplus expanded massively during the past decade. The real motor behind Chinese and Asian growth has always been entrepreneurialism—seeking out opportunities and profits wherever they lie.
As China continues to develop and enrich the lives of its citizens we believe that issues related to the environment, health care, pension provision, and saving and investment decisions will move to the forefront. This is the infrastructure spending that will drive the productivity of the Asian household—not just the roads, buildings, railways and new cities that are popping up but the unseen infrastructure: the abstract, virtual, legal and financial infrastructure that surrounds new media, better banking services, home and car loans, health and property insurance, and financial services. These industries have changed dramatically and promise continued change.
Buy and Hold
The severe disruptions in the global economy appeared to sound the death knell of an investment icon of the last two decades—the buy and hold strategy. Indeed, some of the voices sounding its death knell have been prominent. We disagree—we continue to embrace buy and hold.
On a fundamental level, the alternative to a buy and hold strategy is extremely unattractive, i.e., “sell and give it all away.” After all, you have to hold something—even if it is cash or gold or consumer goods. Any asset will have a return relative to anything else—cash is only safe if inflation does not erode its value and bonds are safe only if the credit is good. Each asset has a risk associated with it. Balancing out those risks is the job of intelligent strategic asset allocation or tactical buying and selling. The latter is hard to do successfully and incurs high transaction costs. The former at least affords some kind of protection against risk—be it volatility or risk of the kind that we have seen recently. Anyone who rejects buy and hold implies that they consistently know more than the market—that they can make frequent correct decisions regarding when to dip in and out of and switch to and from the multitude of available assets, and that they are capable of foreseeing all the twists and turns that lie ahead. We do not claim this ability for ourselves—and I don’t think I have ever met anyone who has reliably demonstrated it.
We don’t expect to be able to see the future perfectly. That is not how we approach stock selection. We seek only to find good companies that, through a mixture of the economics of their industry or business and the reliability and savvy of their management, could have the flexibility and strength to withstand the inevitable vagaries of the market. We also look to find the right type of security associated with the company—equity, debt or convertible—and the right price that may help us navigate the ever changing conditions in as secure and profitable a way as possible.
From our point of view, to pursue a buy and hold strategy is not to ignore the uncertain future, but to accept it. It is not a suggestion that we know or see the future clearly, but the secure recognition that we cannot. While we cannot predict every development in the markets, we do anticipate an upward trajectory in Asia’s growth that we want to participate in on behalf of our shareholders. All we can do then is use our judgment to benefit from this growth in a manner in which we are cognizant of the risks involved.
A Personal Note
On a personal note, it is an exciting time to be named Chief Investment Officer at Matthews. I can’t help but think that many of Asia’s best years still lie ahead. I am enthusiastic about the opportunity to participate in Asia’s future through the implementation of a style and strategy of investing in which I firmly believe. I am privileged to work with a team of talented investment professionals, who inspire me to develop the investment solutions to grow wealth by investing in, what are for me, the world’s most exciting markets.
As always, we are honored to serve as your Asia investment specialists and thank you for your investment in the Matthews Asia Funds.
Robert J. Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC