Matthews Emerging Asia Fund

Period ended June 30, 2018

For the first half of 2018, the Matthews Emerging Asia Fund returned -10.90% (Investor Class), while its benchmark, the MSCI Emerging Markets Asia Index, returned -4.93% over the same period. For the quarter ending June 30, the Fund returned -10.84% (Investor Class), while its benchmark returned -5.75%.

Market Environment:

Asian and global emerging markets (EM) suffered during the first half of 2018. Negative investor sentiment arose from the confluence of escalating U.S.—China trade tensions, seemingly tighter monetary conditions in China and other parts of EM and the oscillation of North Korean denuclearization talks. In addition, a stronger U.S. dollar and higher energy prices exposed the vulnerabilities of some emerging market economies.

Vietnam's equity markets were down slightly during the first half of 2018, following a significant run-up in 2017. Vietnam's economy remained stable in our view, however, with positive GDP growth and strong domestic consumption trends. Meanwhile, Pakistan's equity markets were down sharply in the first half of the year. Worries about rising oil prices adding to Pakistan's current account imbalance weighed on investor sentiment, as did upcoming election cycles. Indonesia's equity markets also experienced significant declines during the first half. Indonesia faces both regional and presidential elections in the next 12 months, creating political uncertainty in the region, although we believe Indonesia's economy remains well-positioned from an economic standpoint.

Elsewhere, India's equity market was down in the first half of the year. Macro headwinds captured headlines in the second quarter as India's reliance on energy imports and a deteriorating current account pressured the Indian rupee and brought inflation concerns to investors. On a positive note, economic growth remained robust in India and corporate earnings momentum showed improvement.

Performance Contributors and Detractors:

During the first half of the year, the Fund underperformed its benchmark. Part of the Fund's underperformance was due to two stocks that experienced sharp sell-offs in the first and second quarters. Shares of Vakrangee, an Indian software company, lost nearly 69% of their value in the first six months of the year, driven down by unsubstantiated rumors of a stock price manipulation scheme. Meanwhile, shares of PC Jeweller, an Indian jewelry manufacturer, previously one of our better performers over the past few years, lost nearly 72% of their value over the same period on unsubstantiated rumors that it manipulated its financial data. We are monitoring both positions closely. Both securities now represent fairly low positions in the portfolio based on their lower share prices, so we will retain our shares until the rumors are clarified and/or we lose confidence in the firms. We believe both businesses offer value at this point and have interesting long-term prospects.

Despite a challenging first half for some of the Fund's holdings, there were some notable bright spots in the portfolio. Berger Paints Bangladesh, a manufacturer of paints and varnishes, generated an over 31% return in the first six months, versus the broader Bangladesh equity market, which was down by more than -9% in the same period. Berger Paints has a strong management team and solid market position, benefiting from the strength of the local consumer in a fast-growing economy. Shenzhou International Group Holdings, a Chinese-based apparel company with operations in Vietnam, generated more than 30% in returns during the first six months, versus the broader offshore Chinese equity market, which was down -1.69% in the same period. Shenzhou International Group manufactures apparel for leading global brands and has been a strong performer.

Notable Portfolio Changes:

We added to positions selectively in the second quarter as we saw quite large moves in various markets. In Indonesia, we added to Gudang Garam, a leading cigarette manufacturer, and Ramayana Lestari Sentosa after currency concerns pushed the market lower. We also added to our two motor company positions in Pakistan, Indus Motor and PAK Suzuki Motor, as valuations became extremely attractive. We also added to our position in Tongda Group Holdings, a Hong Kong-based manufacturer of electronic components, after a steep correction, retaining the view that the company's growth prospects remain attractive. During the quarter we also reduced our exposure to select positions as valuations rose materially. These sales included Shenzhou International and Vietnamese conglomerate Masan Group.


Going into the third quarter, we may see trade friction dampen sentiment but other positive factors may remain. U.S. and Chinese GDP growth remains robust and supportive of the global economy. Commodity prices are high enough to fund the budgets of cyclical exporters and regional currency valuations support foreign investment. In addition, local interest rates are probably high enough to compensate investors for risks and corporate earnings remain relatively strong, making current equity valuations attractive. The strongest headwind seems to be uncertainty derived from escalating U.S.—China trade tensions.

While investor sentiment is weak, the fundamental reasons for owning emerging Asian equities are still very much intact. As sentiment and share prices seem to diverge from the positive fundamental trends we are seeing at the company level, we believe the current volatility may create buying opportunities for long-term investors. We expect less-developed markets to shine over the long term as rising domestic demand for consumer goods and services has the potential to drive solid revenue and strong earnings growth.

As of 6/30/2018, the securities mentioned comprised the Matthews Emerging Asia Fund in the following percentages: Vakrangee, Ltd. 0.5%; PC Jeweller, Ltd. 1.3%; Berger Paints Bangladesh, Ltd. 1.8%; Shenzhou International Group Holdings, Ltd. 2.4%; PT Gudang Garam 2.3%; PT Ramayana Lestari Sentosa 2.1%; Indus Motor Co., Ltd. 2.1%; PAK Suzuki Motor Co., Ltd. 1.5%; Tongda Group Holdings, Ltd. 3.2 %; Masan Group Corp. 1.2%. Current and future portfolio holdings are subject to risk.

Visit our Glossary of Terms page for definitions and additional information.

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.