Matthews Asian Growth and Income Fund
Period ended December 31, 2018
For the year ending December 31, 2018, the Matthews Asian Growth and Income Fund returned -10.96% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned -14.12%. For the fourth quarter of the year, the Fund returned -6.57% (Investor Class) versus -8.60% for the Index.
The last few weeks of 2018 were somewhat emblematic of a year that was rife with volatility. A confluence of geopolitical tension between the U.S. and China manifesting in the trade war as well as tightening U.S. dollar liquidity, slowing growth in China and Eurozone concerns all weighed on asset values. With this, the 2016-2017 narrative of globally synchronized growth swiftly ended. This was compounded by a reminder that developed markets are late in the market cycle, valuations are stretched and global debt levels remain egregiously high.
These factors led all Asian equity markets to finish lower for the year, as price-to-earnings ratios contracted, growth came in below expectations and currencies fell against the greenback. The weakest of these markets were South Korea and China, with much of the prior year's price rally unwound.
Performance Contributors and Detractors:
The portfolio's more-conservative nature alongside its allocation to convertible bonds were both helpful to protecting the Strategy from some of the drop in markets that began in earnest in January. Contributors to returns for the year came largely from the utilities and health care sectors. Guangdong Investment rose as the water utility displayed solid operating profit growth and as there was some excitement over the company's role within the mainland government's vision for the Greater Bay Area. Fellow utilities CLP Holdings and Glow Energy, power producers in Hong Kong and Thailand respectively, gained due to their defensive nature. Within the health care sector, Australian blood plasma derivatives company CSL Limited delivered double-digit growth as core products delivered and the company maintains a strong R&D pipeline. Sleep apnea device maker ResMed gained as strong mask and device growth was driven by its impressive connected-care strategy. Elsewhere, the portfolio's holdings in communication services helped relative performance as shares of telecoms such as HKT Trust gained on price increases in unlimited data plans, and as shares of new addition Tencent Holdings rose from their low in October as fears ended over freezes in the game-approval process in China. This helped to drive performance in the fourth quarter.
The largest detractors to performance for the year came from stock-specific challenges. The weakest of these was South Korean insurer Orange Life. The former ING business witnessed a majority stake sale by a local private equity fund to Shinhan Financial Group at a premium. Unfortunately, the stock dropped on concerns that poor corporate governance standards in South Korea allow no tag-along rights for minority shareholders. Consumer stocks such as Genting Malaysia also fell as the government raised its casino license fee and gaming taxes more than expected to increase fiscal revenues. Further, the company suffered as previous theme park partner Twenty-First Century Fox pulled out of its memorandum of agreement after much of the project had already been built but prior to opening. Genting launched a lawsuit in an attempt to reclaim these expenses as well as to seek punitive damages. Indonesian department store Matahari fell as rising competition from online and specialty retail, alongside some corporate governance concerns, weighed on the stock. We exited our position earlier in the year.
Notable Portfolio Changes:
2018 continued to be an active year in the fourth quarter as we added two new equity holdings and one convertible bond.
We have long been admirers of Tencent's business model as it is clearly the No. 1 games and social networking service within China, offering a huge range of services to its customers. Those network effects are enhanced by a high-caliber management team that helps to create a strong economic moat. Further, corporate governance is better than in much of the sector and there is scope for continued high growth through mobile games, advertising revenues, other services and principal investments. Our challenge with the stock had been valuation, but the 46% drop in its share price earlier this year allowed us to take a position at a more reasonable, although not cheap, 26x P/E.
We also added a position in Australian packaging and distribution company Orora. We believe that the company has a strong moat through its customer relationships, cost advantages and manufacturing sophistication. Further, there are still opportunities for organic growth through volumes rising for paperboard as well as some cost savings accompanied by potential inorganic M&A. We believe that the stock is attractively valued for a leader at 9x EBITDA and a 4.3% dividend yield.
The convertible bond addition was in Huazhu Group where we gained what we think is exposure to the high-growth sector of Chinese hotels through a market leader that operates the second-largest chain in the country. We entered the hybrid as we believed it offered compelling positive asymmetry in its prospective outcomes given an underlying equity that can be fairly volatile.
We funded these new positions through the sales of Japan Tobacco, Hang Lung Properties and SkyCity Entertainment Group.
A continuation of the rise in volatility is likely to be the order of the day in 2019 as a number of the macroeconomic concerns mentioned above are expected to dominate headlines. The U.S.-China trade war and geopolitical tensions are here to stay. They are accompanied by slower growth in China, potential deflationary pressure, a heavy election year across Asia, sputtering reform in much of the region and a continuation of quantitative tightening from G3 central banks. These are all potential macroeconomic volatility generators.
Despite this, the microeconomic picture appears more positive. Headline valuations for the MSCI All Country Asia ex Japan Index are supportive at around 11.5x P/E and, although earnings estimates are being cut, they are still pointing to reasonable growth in the high single-digit range. Further, we are constructive on the outlook for the Strategy as it typically fares better in periods of increased volatility and dispersion. 2018 was a fairly active year, allowing us to add to our stable of what we believe to be leading companies at reasonable valuations. That leaves the portfolio trading at 14.5x P/E, a 3.5% dividend yield and with companies growing in the mid to high single-digit range, providing fairly attractive portfolio metrics.
As of 12/31/18, the securities mentioned comprised the Matthews Asian Growth and Income Fund in the following percentages: CLP Holdings, Ltd. 1.6%; HKT Trust & HKT, Ltd. 1.6%; Tencent Holdings, Ltd. 2.5%; Orange Life Insurance, Ltd. 1.5%; Genting Malaysia Berhad 1.3%; Orora, Ltd. 1.4%; and Huazhu Group, Ltd. Cnv., 0.375%, 11/01/2022 1%. The Fund held no positions in PT Matahari Department Store; Guangdong Investment Ltd.; Glow Energy Public Co., Ltd.; CSL Ltd.; ResMed Inc.; Japan Tobacco, Inc.; Hang Lung Properties, Ltd.; SkyCity Entertainment Group, Ltd.; ING Group; Shinhan Financial Group; or Twenty-First Century Fox, Inc. Current and future portfolio holdings are subject to risk.
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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.