Matthews Asia Innovators Fund

Period ended June 30, 2019

For the first half of 2019, the Matthews Asia Innovators Fund returned 19.09% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 10.83% over the same period. For the quarter ending June 30, 2019, the Fund returned 1.67% (Investor Class), while the benchmark returned -0.56%.

Market Environment:

Asia's capital markets rallied at the start of the year, led by Chinese equities. Volatility flared in May, followed by a rebound for equity prices in June. The dominant factors driving Asia capital markets over the short term were political, stemming from rhetoric around trade relations between the U.S. and China. Following the recent G-20 Summit, the tone of dialogue surrounding trade issues improved, even though negotiations provided few details and trade issues are likely to linger. Despite recent volatility, China's domestic markets and the Hong Kong market were among the best-performing markets in Asia.

As economic data in the U.S continued to soften, the U.S. Federal Reserve began to use language suggesting the potential for future rate cuts. The prospect of lower U.S. rates provided support to Asian and emerging market currencies against the U.S. dollar as well as allowed emerging market central banks to ease monetary conditions to support their economies. While China's policymakers have not yet rolled out significant stimulus, market participants seemed reassured by incremental shifts in policy support for economic growth.

Performance Contributors and Detractors:

The Fund outperformed its benchmark in the first half, as well as in the second quarter. An important contributor to performance was stock selection in China. When the U.S.–China trade negotiations faltered toward the end of 2018, we saw an opportunity to buy quality Chinese growth stocks at lower valuations. We took advantage of market conditions to concentrate our China holdings into fewer positions, while adding to some of our existing, higher-conviction names. This approach yielded strong results in the first half as Chinese equities rallied, outperforming the rest of Asia. A mild detractor from performance during the period, meanwhile, was stock selection in South Korea.

Among individual stocks, a major contributor during the first half was China International Travel Service, an operator of duty-free stores. With a dominant market position in duty-free stores in China, the company has been well-positioned to take advantage of several secular trends, including increased outbound Chinese travel, rising incomes and rising luxury sales. Consumers who used to make duty-free purchases abroad can now make them at home. The company's focus on China's domestic consumers provides attractive growth potential and we believe the company has demonstrated strong execution on its marketing plans.

In contrast, South Korean food producer Orion detracted from performance. The company's stock price declined on slowing domestic sales growth, but we remain constructive on the company's underlying business model. In addition to selling its products in South Korea, it also sells in Vietnam and Russia, where sales have been stronger. Orion's product innovation remains sound and we continue to like the company's long-term prospects, so we will continue to monitor and evaluate the position.

Notable Portfolio Changes:

During the second quarter, we added several new stocks to the portfolio. Among these new positions, Innovent Biologics is one of China's largest biosimilar companies, with a strong pipeline of new products in development. We believe Innovent is well-positioned to capture market share in oncology treatments. Another new Chinese health care company, drug manufacturer Hansoh Pharmaceutical Group, is a recent IPO in China's domestic A-share market. Hansoh focused on oncology, as well as other treatments. Turning to South Korea, we added pharmaceutical company Hugel, which continues to innovate, revamping its product line-up and channel strategies. During the second quarter, we exited several positions, including the Mumbai-based Induslnd Bank and Bangkok-based banking group Kasikornbank. In both cases, we were seeking to replace these holdings with higher quality, more innovative companies.


Looking ahead, we expect interest rates to ease or hold steady, while oil prices seem to remain in check. Both conditions are positives for Asia currencies. China's policymakers also have signaled a willingness to take a more proactive stance in using fiscal and monetary policy to support growth. Elections in India and Indonesia resulted in wins for the incumbents, adding a sense of political stability in both countries. With elections concluded, reform cycles in both countries could get a boost.

Trade tensions between the U.S. and China present both risks and opportunities. While these tensions can disrupt markets over the short term, we believe they strengthen the case for investing in Asia equities over the long term. China is likely to become increasingly self-sufficient as it looks for ways to replace imports impacted by tariffs and is likely to create shifts in the competitive landscape in the process. Investing with a long-term view, we seek to take advantage of short-term market disruptions by buying quality growth companies at attractive valuations.

Innovative companies will continue to find ways to grow and prosper. Asia's consumers enjoy rising income levels and consistently seek to upgrade their quality of life in areas from health care and education, to technology and consumer staples. The growing purchasing power of the Asian consumer creates attractive opportunities for long-term investors with a sharp focus on innovation.

As of 6/30/2019, the securities mentioned comprised the Matthews Asia Innovators Fund in the following percentages: China International Travel Service Corp., Ltd. 3.7%; Orion Corp. 2.0%; Innovent Biologics, Inc. 1.3%; Hansoh Pharmaceutical Group Co., Ltd. 0.5%; Hugel, Inc. 1.4%. The Fund held no positions in Induslnd Bank, Ltd. or Kasikornbank Public Co., Ltd. Current and future portfolio holdings are subject to ris

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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.