Period ended March 31, 2019
For the quarter ending March 31, 2019, the Matthews Asia Small Companies Fund returned 9.48% (Investor Class), outperforming its benchmark, the MSCI All Country Asia ex Japan Small Cap Index, which returned 8.54%.
During the first quarter of the year, market sentiment reversed sharply from the fourth quarter of 2018 as the U.S. Federal Reserve indicated it would not raise rates in 2019. Additionally, there was increased optimism that the U.S. and China would reach a trade deal after nearly one year of back-and-forth trade negotiations that cast major overhangs for emerging and Asian markets. Thus far this year, most Asian currencies strengthened against the U.S. dollar and Asian equities generally registered reasonable gains. The market also became more constructive on China's growth prospects following the government's easing posture. Chinese equities were the best performers in the Asia region at the start of this year. Indian markets on the other hand were somewhat volatile leading up to the country's general elections. Geopolitical tensions between India and Pakistan also rocked market sentiment. In Indonesia, the country geared up for its presidential election in April. Meanwhile, Thailand's general election took place in late March with the Pheu Thai Party unofficially winning the most parliamentary seats; however, official election results are not expected until May.
Performance Contributors and Detractors:
The portfolio's absolute returns were largely supported by holdings from China/Hong Kong and Taiwan as share prices recovered for most of these companies after previously experiencing steep sell-offs due to macroeconomic and geopolitical concerns during the second half of 2018. The portfolio's holdings in Chinese companies that possess a strong domestically oriented franchise and revenue streams performed strongly due to solid earnings results. Times China Holdings, a real estate developer focused on southern China, was the largest contributor to the Fund's absolute performance. It had consistently shown great project execution capabilities and recent strong earnings further boosted investor confidence in the company.
Meanwhile, some holdings in Vietnam detracted from performance due to negative developments in their operations that might adversely impact growth momentum. As a result, valuation multiples for some Vietnamese holdings contracted. Vietnam's Yeah 1 Group, a media platform company, experienced operating issues with one of its subsidiaries, which could adversely impact the company's growth momentum. Hence, its share price fell sharply and we exited the holding during the quarter.
By sector, most portfolio holdings in consumer staples, industrials, and health care performed well due to company-specific factors and solid earnings results. Some companies operating in the internet space performed below market expectations and saw their share prices suffer, as explained above.
Overall, good stock selection and the portfolio's overweight in China were key drivers for outperformance during the quarter.
Notable Portfolio Changes:
During the quarter we substantially adjusted our holdings in China/Hong Kong and India due to valuation merits and risk/reward profiles across companies operating in a variety of industries. As a result, we took profits in a number of highflyers in China/Hong Kong—either trimming or exiting the positions. We trimmed Yihai International Holding, a leading soup and condiment manufacturer in China due to a strong share price run-up following earnings results. We also exited Bilibili, China's leading online entertainment platform, after the company's market cap grew past US$5 billion after a strong run-up since the summer of last year. With the proceeds, we initiated a position in China BestStudy Education, an after school tutoring operator, which in our view offers good growth exposure to education spending with reasonable valuations.
Some of our holdings in India performed below our expectations. Natco Pharma, a generic drug maker, experienced competitive pressure and uncertainties relating to product launches. Despite undemanding valuations, we believed it would be more beneficial to exit the holding and invest in other companies with more robust growth prospects. Consequently, we increased our weighting in consumer discretionary companies, as well as financial holdings in India, as market corrections last year presented opportunities to build positions at attractive valuations.
As China's stimulus and easing policies start to take hold, we are hopeful that consumer and business confidence will continue to improve and should in turn translate into more robust corporate investments and company fundamentals. Market uncertainties might impact sentiment in the capital markets of India and Indonesia due to general elections. While short-term volatility may be inevitable, we believe that low investor expectations and attractive valuations in some segments of the market present opportunities for long-term, bottom-up stock selection.
We remain focused on seeking opportunities in domestically oriented companies that are beneficiaries of structural growth trends. We believe that over the long term, they have the potential to compound in size and reward shareholders, although market participants at times could be overly focused on the short term, de-emphasizing company fundamentals.
With a growing middle class and a dynamic entrepreneurial landscape in Asia, many of the region's small companies are poised to grow because their domestic revenue streams are less impacted by global factors. We continue to be constructive on efficient and innovative companies, particularly those in the health care, communications and information technology sectors.
As of 3/31/2019, the securities mentioned comprised the Matthews Asia Small Companies Fund in the following percentages: Times China Holdings, Ltd. 2.4%; Yihai International Holding, Ltd. 1.9% and China Beststudy Education Group 1.0%. The Fund held no positions in Yeah1 Group Corp, Bilibili, Inc. or Natco Pharma, Ltd. Current and future portfolio holdings are subject to risk.