Period ended December 31, 2019
For the year ending December 31, 2019, the Matthews Asia Strategic Income Fund (re-named the Matthews Asia Total Return Bond Fund as of January 31, 2019) returned 13.00% (Investor Class), while its benchmark, the Markit iBoxx Asian Local Bond Index, returned 8.99%. For the fourth quarter, the Fund returned 3.53% (Investor Class) versus 2.80% for the Index.
2019 was a tale of trial, caused by political and economic turbulence. By the fourth quarter, it also was a tale of triumph. The year started with a strong rally, which was cut short by a surprise escalation in the trade war by the Trump administration in May. Negativity in the markets was compounded by rapidly declining global manufacturing PMI, a key gauge of global activity, which had been declining since late 2018 and slipped to contractionary levels (i.e., below 50) by May.
Acknowledging growing risks, the U.S. Federal Reserve put rate hikes on pause and eventually cut rates twice. U.S. Treasury yields decreased by 102 basis points in the first three quarters of 2019. The Fed action was supportive of the U.S. and global economies, though not enough to curb growing fears of recession. Yields across Asian local government markets came down, helped by dovishness from the Fed, which allowed other central banks to cut rates.
In many ways the fourth quarter, December in particular, was a reversal of much of the previous six months. On December 12, the White House indicated that a “phase one” trade deal had been reached, paving the way for a risk-on rally into year end. Asian equities outperformed the S&P 500 Index. Within fixed income, high yield outperformed investment grade bonds. In fact, returns for U.S. Treasuries were negative, in a quick reversal of their strong performance throughout 2019. The risk-on mood also helped local currency assets outperform, driven by stronger foreign exchange (FX) versus the U.S. dollar (USD).
Markets saw the partial trade deal as a positive development because a December tariff increase was taken off the table, and the initial agreement was seen as boding well for a permanent tariff détente. With Trump and Xi increasingly aware of the economic costs of the trade war, both appeared to be turning more pragmatic. All of this warranted a re-rating of risk in the markets.
Within Asian local government markets, almost all countries posted positive returns in the fourth quarter—except Hong Kong and India, both driven by idiosyncratic issues. In Hong Kong, protests depressed economic sentiment. In India, the increase in inflation, driven by food prices, hampered policymakers' ability to further ease policy, which was needed for the economy to recover from a crisis in the non-banking financial sector.
Performance Contributors and Detractors:
For 2019, USD-denominated high yield positions, particularly Chinese property companies, were the top-returning holdings in the portfolio. Since sentiment around Chinese property became negative in 2018, it set the sector up for outperformance in 2019 as many of the risks impacting the sector faded throughout 2019. These risks included de-leveraging efforts in China, rising U.S. interest rates and escalation of the U.S.–China trade war. South Korea FX and rates were the biggest detractors, generating negative returns. South Korea was the main target of selling due to trade war and global slowdown fears since it is heavily reliant on manufacturing and open to trade.
For the fourth quarter, the biggest contributor to outperformance came from USD-denominated high yield bonds. Local currency assets also did well, driven primarily by FX returns. Our top Asian FX positions were in Chinese renminbi and Indonesian rupiah, which were the top contributors to FX performance in absolute terms.
In terms of rates, the underweight to overall duration contributed to outperformance as U.S. Treasuries and government yields around the world rose in the fourth quarter. In absolute terms, our local rates positions in Indonesia and India were the biggest contributors, as these benefited from the risk-on sentiment.
In terms of USD-denominated high yield, the top contributors came from the Chinese property sector and Bharti Airtel. After the Supreme Court of India settled a long-standing case on telecom sector taxes, Bharti Airtel said it planned to raise new equity and convertible bonds to shore up its balance sheet, leading to a sharp rebound in bond prices.
Among the biggest detractors to returns were our positions in Perusahaan Listrik Negara (PLN), Debt and Asset Trading and Baozun. PLN and Debt and Asset Trading are both quasi-sovereigns of Indonesia and Vietnam, respectively. Baozun was added after a sell-off and we will allow time for our investment thesis to play out.
Notable Portfolio Changes:
For the first three quarters of 2019, the main impetus of change for the portfolio was toward weathering a protracted trade war and downshift in economic activity. To that end, we looked to add interest-rate duration, in both the U.S. and Asian countries. We shifted out of some lower-quality, higher-yielding bonds toward higher-quality bonds, such as PLN, Cikarang Listrindo and local currency rates in Malaysia, Thailand, Indonesia and India. In addition, we reduced our FX exposure to Asian currencies, with the biggest underweight relative to the Index coming from the Korean won.
As the outlook brightened, we made a number of changes to the portfolio in the fourth quarter. In currencies, we added to our exposure to Chinese renminbi, believing that the market had priced in too much negativity around a trade deal. We also added to our exposure to Chinese corporates, taking on new positions in Baozun, iQIYI, Sino Ocean, and Far East Horizon.
In rates, we exited our position in Indian five-year swaps, which had gained from multiple Reserve Bank of India policy-rate cuts throughout the year. We felt that the risk/reward going forward was more balanced and thus took profits.
We believed that most of the gains in U.S. duration had already been realized and chose to pare back our U.S. rate duration and rate sensitivity. To that end, we exited our positions in PLN, Cikarang Listrindo, and Standard Chartered perpetual bonds.
Finally, we initiated a position in Bharti Airtel, an Indian telecom company that is one of the top operators in the country.
Looking to 2020, we have learned from 2019 that political risks ebb and flow, but fundamental analysis remains key to outperformance. The market is seemingly struggling to price geopolitical risks. We expect this to present opportunities to drive returns through security selection. In 2019, fundamental analysis drove our conviction to hold higher-beta securities in the portfolio—be it high yield over investment grade, or long-dated bonds over short-dated ones—which helped the Fund outperform.
Market fundamentals give us reason to be optimistic heading into 2020. Global Manufacturing PMI is showing signs that it might have bottomed in the fourth quarter of 2019, paving the way for outperformance of cyclical sectors. For Asia, which is driven by manufacturing, this is a welcome sign. Semiconductors sales, which are heavily correlated to global growth and growth in Asia, seem to be rebounding. In terms of valuation, Asian currencies and Asian high yield continue to look attractive. Thus, we believe stronger fundamental tailwinds could drive Asian fixed income to outperform its global counterparts in 2020.
As of 12/31/2019, the securities mentioned comprised the Matthews Asia Strategic Income Fund in the following percentages: Network i2i, Ltd., 5.650%, 04/15/2068 (Bharti Airtel) 4.2%; Debt and Asset Trading Corp., 1.000%, 10/10/2025 4.5%; Baozun, Inc., Cnv., 1.625%, 05/01/2024 1.5%; iQIYI, Inc., Cnv., 2.000%, 04/01/2025 1.8%; Sino-Ocean Land Treasure III, Ltd., 4.900%, 03/21/2068 1.0%; King Talent Management, Ltd., 5.600%, 06/04/2068 (Far East Horizon) 2.7%; Currency Contracts, Korean Won on 01/31/20 @ 1,175.7000000 0.1%; Currency Contracts, Thai Baht on 01/21/20 @ 30.7300000 0.1%; Currency Contracts, Indian Rupee on 03/06/20 @ 74.0200000 -0.1%. The Fund held no positions in PT Perusahaan Listrik Negara; PT Cikarang Listrindo; or Standard Chartered PLC. Current and future portfolio holdings are subject to change and risk.