Matthews Asia Innovators Fund

Period ended September 30, 2018

For the quarter ending September 30, 2018, the Matthews Asia Innovators Fund returned -10.50% (Investor Class) while its benchmark, the MSCI All Country Asia ex Japan Index returned -1.45%.

Market Environment:

Many Asian and global emerging markets suffered during the third quarter amid a confluence of challenging macroeconomic headlines. Escalating trade tensions between the U.S. and China, seemingly tighter monetary conditions across many parts of the world and higher energy prices exposed vulnerabilities of certain emerging markets economies. Market weakness was significant at times during the quarter, especially in China as positive news was visibly absent.

Sentiment toward China's equity markets was largely negative on worries about trade conflicts, as well as rising regulatory risks. In the online gaming industry, the government has stopped issuing new licenses for new products on concerns that children are spending too much time playing online games. In the education segment, the government is increasing its oversight of private tutoring services, limiting the hours when tutoring can be provided and preventing private service providers from overburdening students with additional homework.

As trade tensions between the United States and China intensified during the quarter, market participants worried about spillover to broader Asia. Higher growth and inflation in the U.S. continues to support higher U.S. interest rates and a marginally stronger U.S. dollar has influenced Asian central banks to increase local interest rates and keep their currencies competitive. In addition, oil prices keep climbing, acting as a headwind for many of Asia's economies.

Performance Contributors and Detractors:

The Fund significantly underperformed its benchmark during the quarter, largely due to a pullback in growth stocks in China. As long-term investors, we viewed the pullback in Chinese growth stocks as a buying opportunity, allowing us to add to existing portfolio holdings, changes we discuss in the next section. The Fund is benchmark-agnostic by design, so variances from the benchmark are normal and can be significant over the short term. Over the long term, we strive to generate attractive relative and absolute performance over a full market cycle.

Detractors from performance during the quarter included Chinese tech giants Tencent and Alibaba. Tencent, one of China's largest providers of internet services, owns and manages the popular WeChat messaging service. Alibaba is one of China's largest e-commerce retailers. Both companies experienced significant run-ups in their stock prices last year, and both have faced significant stock price declines this year on weak investor sentiment. While stock prices for these companies suffered major corrections, both companies are dominant players with strong competitive moats, so we still like the prospects of both companies when taking a long-term view.

A positive contributor to performance was Taiwan Semiconductor Manufacturing, a leading provider of advanced design computer chips. Taiwan Semiconductor Manufacturing currently offers a style of semiconductor that none of its competitors has the ability to manufacture. In addition, the semiconductor industry has undergone a good bit of consolidation in recent years, leaving fewer competitors in the high-end space. Accordingly, its stock price rose on positive fundamentals.

Notable Portfolio Changes:

During the quarter, we took advantage of market volatility to add to our positions in Tencent and Alibaba. Following a sell-off of growth stocks in Chinese equity markets, the stock valuations of both companies looked very attractive and we believe both still have plenty of room for future growth. Alibaba, for example, is aggressively expanding into cloud-computing services, creating the potential for new revenue streams that we believe are not yet reflected in its stock price.

We also added positions in Sun Art Retail, a Chinese grocery chain, and, a Chinese provider of online classified ads. Alibaba recently bought a significant stake in Sun Art Retail in hopes of helping Sun Art introduce an innovative new retailing model that combines online ordering capabilities with pick up and distribution via brick-and-mortar stores. Groceries are one of the final frontiers for China's e-commerce business, so we are encouraged by the prospects for Sun Art's collaboration with Alibaba. Turning to, we believe the firm benefits from a strong presence in underserved markets, including many of China's interior, lower-tier cities. As classified advertising is typically a local business, has a strong head start in advertising jobs, cars and real estate locally.

During the quarter, we exited a couple of companies we felt were subject to rising regulatory risk in China. These positions included NetEase and TAL Education Group. NetEase provides online gaming content, while TAL Education Group provides afterschool tutoring services. As both industries are subject to growing government restrictions and regulations, we decided to exit these positions.


Looking ahead, we will keep an eye on trade concerns and how they may impact economies across Asia. Many Asia economies are increasingly driven by domestic consumption, providing a bit of insulation against trade conflicts. Trade conflicts, however, can also weigh heavily on both investor and consumer sentiment. Should local consumers lose confidence in their economies, it could dampen consumer spending. We will also keep an eye on regulatory risks, particularly in China, where the government has been playing a fairly high-profile role in industries such as private education. We generally seek out companies with reduced exposure to regulatory risks and increased exposure to secular growth trends that are likely to continue through organic upgrades in consumer expectations and demand.

While there is potential for additional market volatility to come, we also see reasons to be optimistic. Across the region, economies are growing, consumers are spending and wages are rising. And we will continue to invest with a long-term view, taking advantage of short-term dips in the market to buy high-quality companies with attractive growth potential. As always, we will employ a bottom-up, boots-on- the-ground approach to identifying Asia's most innovative companies.

As of 09/30/2018, the securities mentioned comprised the Matthews Asia Innovators Fund in the following percentages: Tencent Holdings, Ltd., 5.4%; Alibaba Group Holding, Ltd., 5.5%; Taiwan Semiconductor Manufacturing Co., Ltd., 3.5%; Sun Art Retail Group, Ltd., 1.8%; and, Inc., 2.0%. The Fund held no positions in NetEase, Inc. or TAL Education Group. 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.