Matthews Asia Total Return Bond Fund

The Fund's name changed from Matthews Asia Strategic Income Fund to the Matthews Asia Total Return Bond Fund on January 31, 2020. For more information, please read our Q&A: Fixed Income Retooling.

Period ended March 31, 2020

For the quarter ending March 31, 2020, the Matthews Asia Total Return Bond Fund returned -12.66% (Investor Class), while its benchmark, the 50% Markit iBoxx Asian Local Bond Index/50% J.P. Morgan Asia Credit Index, returned -3.67%.

Market Environment:

The first quarter of 2020 was characterized by market reactions to a global pandemic caused by Covid-19.  Unlike crises of past two decades, this one resulted in a sudden stop of economic activity for a broad percentage of the global economy. The velocity of the selloff and the breakdown in correlation amongst asset classes was unprecedented. While it's too early to say that we're past the trough of the crisis, the toughest weeks in March were characterized by a dash for cash and a dollar panic. As investors grappled with the double whammy of Covid-19 and the breakdown in talks amongst the biggest oil producers, investors sold indiscriminately to raise cash—essentially a run on all financial assets. All assets tumbled, both risky assets and safe haven assets such as gold and U.S. Treasuries were being sold for U.S. dollars.  Correlations converged to 1. It was at this time that credit spreads and yields rose across local currency Asian bonds. In response, the U.S. Federal Reserve promise to “do whatever it takes” to restore stability at the low-risk end of the market—buying investment grade credit, agency mortgage-backed securities,  commercial mortgage-backed securities, and municipal bonds in the U.S. and providing dollar swap lines with foreign central banks—provided some reprieve. At the time of writing, we have slipped from the third stage of “Dash for cash” back to the second stage of the markets trying to assess the length and depth of a global recession resulting from a sudden stop of global economic activity.

Ironically, the eye of the storm, China has been the safest so far, followed by North Asia. In the first quarter, Chinese High Yield as represented by the China portion of JP Morgan Asia Credit High Yield Total Return Index returned -8.0% while U.S. High Yield, as represented by the Bloomberg Barclays US High Yield Total Return Index returned -12.7%. Asia credit also outperformed EM credit, as the JP Morgan Asia Credit Index returned -3.47% while the JP Morgan Emerging Market Bond Total Return Index —Global subindex returned -12.6%. Asian currencies outperformed both developed and wider emerging market currencies: Asian currencies in the Markit iBoxx Asian Local Bond Index returned on average -4.8% versus -6.5% for Developed Market currencies and -13.1% for EM currencies.

China, and then North Asia, were the first to face the COVID-19 pandemic, the first to employ strict measures against it, and the first to have complete coronavirus case curves for financial markets to make sense of. In contrast, climbing coronavirus curves in countries elsewhere, including the U.S. and Europe, present a lingering uncertainty for their markets. For the U.S. and non-Asian EM countries, the fall in oil prices represent another credit risk. Oil at US$20-30 a barrel is lower than the long-term break-even cost of most U.S. shale players and EM oil exporters, hence why Saudi Arabia drove the prices so low to gain market share.

Performance Contributors and Detractors:

During the first quarter, a key driver of performance was the Fund's exposure to USD high yield issuers, which sold off in the risk-off environment, with high yield spreads widening by over 400 basis points (4.0%). In general, lower-rated bonds underperformed higher-rated bonds. In terms of geography, China issuers made up a large portion of our high yield exposures, and were also the biggest detractor to performance, particularly real estate names.  Indian and Indonesia high yield exposures also contributed to the negative performance.

Within currencies, our underweight to most local Asian currencies contributed to performance given the strong USD environment and the depreciation of Asian FX across the board.

Notable Portfolio Changes:

During the quarter, we increased our exposure to Malaysia through local government bonds and to China, through a local investment grade-rated corporate bond, Cinda Asset Management. This boosted our allocation to relatively safe duration. Additionally, we reduced our exposure to India by selling local corporate bonds, taking rates and currency in India to underweight. We reduced our exposure to India as we believe the Indian local market lagged the risk-off sentiment seen in other global markets.

On currencies, we increased our exposure to the Thai baht and the Korean won.

Finally, we added investment grade U.S. dollar-denominated bonds, such as Geely and Jollibee. We believe these names had been overly punished throughout the coronavirus sell-off. We also added Bosideng, a down jacket brand in China, which we believe should benefit in the long run to increased Chinese consumption.

Outlook:

Given the multitudes of unknowns, we are back-solving into market expectations based on current security prices. Out of credit, currency, and interest rates, we expect the most upside from credit, followed up interest rates, with currencies potentially having the most negative skew. With Asia high yield credit spreads hovering around 1,000 basis points (10.0%) which were all time wides experienced during the global financial crisis (GFC), we believe that that current prices are more than compensating active investors who can lock in current yields and avoid defaults. The forced selling of these bonds due to margin calls have also subsided as price moves are no longer as violent as during the “Dash for cash” stage of the crisis. With the epicenter of the crisis having moved from China to the rest of the world, we expect Chinese credits, especially of issuers in domestically driven sectors like property to be amongst the first to recover as they trade at a substantial discount to intrinsic value.

We see interest rates for most Asian countries having more room to fall as central banks continue to cut rates to stimulate their local economies.  We expect this to not only be true for the developed economies of north Asia, but even for the emerging economies of India and Indonesia as the most worrisome negative spillover of low rates stoking inflation remains a low probability given the sudden stop of economic activity. As such, we see falling rates as also providing a positive tailwind for Asia local currency bonds. Lastly, we are most concerned about currencies as it is most difficult to determine their intrinsic value. Most Asian currencies have not depreciated to the trough levels of the GFC, although the velocity of the depreciation has exceeded that of the GFC. We are especially concerned about the emerging economies of India and Indonesia as their relatively large populations and underdeveloped health infrastructure make these economies most vulnerable.

We expect the portfolio's mix of high quality bonds, in U.S. dollar and local currency, will cushion further downside, and preserve our ability to generate returns when we emerge from the current market environment. We know that volatility goes parabolic during times of stress, when correlations converge to 1. With the “dash for cash” having subsided, at least for now, we are seeing correlations moving in the right direction.


As of 3/31/2020, the securities mentioned comprised the Matthews Asia Total Return Bond Fund in the following percentages: China Cinda Asset Management Co., Ltd. 1.6%; Geely Automobile Holdings, Ltd. 0.5%, Jollibee Worldwide Pte, Ltd. 1.4% and Bosideng International Holdings, Ltd. 3.7%; Currency Contracts, Thai Baht on 07/21/20 @ 30.2100000 -0.2%; Currency Contracts, Korean Won on 07/29/20 @ 1,160.0000004 -0.3%; Currency Contracts, Korean Won on 07/16/20 @ 1,145.7000000 -0.3%. Current and future portfolio holdings are subject to change and risk.


Fixed income investments are subject to risks, including, but not limited to, interest rate, credit and inflation risks. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid and more volatile than securities markets in more developed markets.

 

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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.