Matthews Asian Growth and Income Fund
Period ended March 31, 2019
For the quarter ending March 31, 2019, the Matthews Asian Growth and Income Fund returned 10.63% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 11.45%.
Markets across Asia rebounded sharply in the first quarter from what had been a fairly negative environment during much of last year. The confluence of tightening U.S. dollar liquidity, slowing growth across much of the globe, a U.S.-China trade war and previously high valuations and earnings expectations were all drags on risk assets during 2018.
In a reminder of how obsessed investors have become with politics and central bank action, much of the concern around these issues has reversed in the past few months. The pivot in outlook and attitude within the U.S. Federal Reserve means that expectations are now for an easing of rates, while there has been increasingly positive murmurs around a U.S.-China trade deal being signed imminently that is believed to deal with tariffs, intellectual property protection and market access. Further, although slower growth remains a risk, China also has stepped away from its deleveraging campaign and is once again engaging in fiscal and monetary stimulus to boost growth.
All these alterations have created significant improvements in sentiment toward emerging market equities. Due to it being at the forefront of these changes, the domestic Chinese market led the region, with all markets in Asia except Malaysia delivering solid returns over a short time period.
Performance Contributors and Detractors:
Although slightly lagging the benchmark, the upside capture for the portfolio during the first quarter was reasonable, with the largest driver coming from the information technology and consumer discretionary sectors. A number of these came from our newer holdings within the mainland Chinese A-share market as the weakness of last year reversed in earnest. Small appliance manufacturer Zhejiang Supor and the country's third-largest baijiu company Jiangsu Yanghe Brewery Joint-Stock gained significantly as they both delivered over 20% earnings growth for the year despite a weakening macroeconomic backdrop. White goods company Midea Group also rose as management plans to consolidate washing machine subsidiary Little Swan, increased automation in its factories and announced a share buyback. Outside of China, Korean consumer companies Coway and LG Household & Health Care (LG H&H) also gained. The former is a water purifier company whose shares rallied on an improvement in sentiment about its ownership structure as well as gained traction in overseas markets such as Malaysia and the U.S. For LG H&H, the personal care company continued to deliver solid growth in its cosmetics business as brands such as su:m and Whoo gained traction with Chinese consumers.
Elsewhere, a number of technology companies such as Taiwan Semiconductor Manufacturing, Broadcom and Advantech all rose as they are set to benefit from the continued growth in silicon content and connectivity that is driven by the megatrends of 5G, industrial automation and the internet of things. Beyond these sector themes, the largest contributor to the portfolio was core holding AIA Group, with the pan-Asian life insurer gaining access to new markets within China such as Hebei and Tianjin.
More negatively, the largest detractor to returns came from Hong Kong conglomerate Jardine Matheson. This was partly a reversal of reasonable relative performance last year and partly due to its subsidiary Dairy Farm, a regional retailer with a large presence in supermarkets, delivering poor results on rising competition and rental costs. Bank of the Philippine Islands also sputtered on weaker-than-expected loan growth and higher provisioning. Beyond these, and despite adding to our China weight over the past couple of years, the Strategy's underweight to the mainland also detracted from relative performance.
Notable Portfolio Changes:
During the quarter we added three new equity positions to the portfolio.
We initiated a position in French luxury goods conglomerate LVMH Moet Hennessy Louis Vuitton. Asia now represents the company's largest geographic segment in terms of revenues. We believe that the quality and diversification of its brand portfolio is unparalleled and underappreciated by the market given its impressive positions across beauty, wine and spirits, watches, jewelry, leather goods and specialist retail items. Solid growth opportunities remain as brand momentum is good and as the company successfully uses digital platforms to drive volumes. The combination of a strong moat, a well-regarded management team, sensible capital structure and a reasonable valuation at 23x price-to-earnings (P/E) ratio and over a 2% dividend yield is attractive.
We also initiated a position in Shanghai International Airport as it is essentially a monopoly asset for inbound and outbound travel in that area. That moat is combined with a competent management team and plenty of growth options as it adds an additional satellite terminal to expand capacity. This will help to drive both aeronautical and non-aeronautical revenues as passenger volumes and commercial areas are expanded. Although the stock is not cheap at 21x P/E, we believe that our position will compound over the medium to long term.
Beyond these, we reinitiated a position in globally leading, Australian blood plasma derivatives company CSL Limited as its shares had fallen from their peak in 2018. We funded these purchases through the sale of VTech Holdings, Café de Coral and the maturation of a convertible bond in Haitian International.
After being somewhat reserved in our outlook at the end of 2018, we have been surprised at the speed and scale of the market rebound during the first quarter. As noted above, there has been a reversal in a number of the factors that drove the weakness in equity markets last year, particularly for those emerging markets that are sensitive to risk appetite and monetary conditions. But those macroeconomic reversals have yet to impact the microeconomic picture. At a fundamental level, we have witnessed a continuation in earnings downgrades, with around 60% of companies in Asia ex Japan missing earnings estimates last year.
The combination of weakening earnings but a significant market rally has led to a re-rating in valuations. Asia ex Japan is now trading at around 13.3x P/E—a level that is by no means stretched, but leaves little room for further sustained multiple expansion. Accompanying that are growth levels that are expected to be in the mid-single digit range.
With that backdrop, we remain constructive on the outlook for the portfolio. Periods of lower but still positive growth alongside elevated volatility are typically advantageous to long-term, active stock pickers like us. We believe the portfolio is filled with high-quality companies that are reasonably valued with sustainable growth opportunities and some current income. That is a combination that we believe should be able to deliver attractive risk-adjusted returns through the cycle, irrespective of a noisy news environment.
As of 3/31/2019, the securities mentioned comprised the Matthews Asian Growth and Income Fund in the following percentages: Zhejiang Supor Co., Ltd. 1.6%; Jiangsu Yanghe Brewery Joint-Stock Co., Ltd. 1.6%; Midea Group Co., Ltd. 1.4%; Coway Co., Ltd. 1.5%; LG Household and Health Care, Ltd., Pfd. 2.0%; Taiwan Semiconductor Manufacturing Co., Ltd. 3.9%; Broadcom, Inc. 2.0%; Advantech Co., Ltd. 2.0%; AIA Group, Ltd. 3.5%; Jardine Matheson Holdings, Ltd. 1.5%; Bank of the Philippine Islands 1.3%; LVMH Moet Hennessy Louis Vuitton 1.3%; Shanghai International Airport Co., Ltd. 1.3%; CSL, Ltd. 1.0%. The Fund held no positions in VTech Holdings Ltd., Café de Coral Holdings, Ltd. or Haitian International Holdings, Ltd. Current and future portfolio holdings are subject to risk.
Visit our Glossary of Terms
page for definitions and additional information.
The views and opinions in this commentary were as of the report date, subject to change and may not reflect current views. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Fund's future investment intent. It should not be assumed that any investment will be profitable or will equal the performance of any securities or any sectors mentioned herein. The information does not constitute a recommendation to buy or sell any securities mentioned.
The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Neither the funds nor the Investment Advisor accept any liability for losses either direct or consequential caused by the use of this information.