Matthews Emerging Asia Fund

Period ended September 30, 2018

For the quarter ending September 30, 2018, the Matthews Emerging Asia Fund returned -4.27% (Investor Class), while its benchmark, the MSCI Emerging Markets Asia Index returned -1.68%.

Market Environment:

Most Asian and global emerging markets suffered during the third quarter amid a confluence of negative 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 market economies. Market weakness was significant at times during the quarter, especially in China as positive news was visibly absent.

India's equity market gave up most of its year-to-date outperformance in September 2018. India was viewed by investors as a safe haven from tariff-related volatility as GDP growth rebounded and negative GST-related effects abated. Rising oil prices, however, are fueling macro headwinds and, along with expensive relative valuations, hit investor sentiment in September. A weaker rupee along with increased inflationary pressures has forced the Indian central bank (RBI) to raise rates and tighten policy.

A few bright spots in the region included the Philippines and Vietnam. Both countries generated positive equity returns during the quarter. Vietnam in particular is enjoying strong macroeconomic conditions. Vietnam's GDP growth has held up and its current account balance remains healthy, supported by strong foreign direct investment (FDI) and exports. The country also has some domestic oil and gas production, leaving it less exposed to rising oil prices.

Performance Contributors and Detractors:

The Fund has a high active share, meaning that it looks dramatically different from its benchmark by design. Approximately three quarters of the benchmark is made up of China, Taiwan and South Korea, markets we consider toward the more developed end of the emerging market spectrum. In contrast, the Fund typically invests in the least-developed end of the emerging market spectrum, including frontier markets, such as Vietnam, Bangladesh and Sri Lanka, which are not included in emerging market benchmarks.

Significant detractors from performance during the quarter included holdings in Sri Lanka and China. Sampath Bank, a leading commercial bank in Sri Lanka, experienced a sharp decline during the quarter. There was no specific catalyst for the price drop other than general negative sentiment in the marketplace. Tongda Group, a Chinese IT company, experienced a significant price decline on negative sentiment toward smartphone handsets, which is among the firm's product lines.

Contributors to performance included two consumer staples companies. Vinh Hoan, a Vietnamese food producer, experienced significant gains in stock price during the quarter. A seller of frozen fish fillets, Vinh Hoan is successfully shifting focus from the U.S. to China, where demand for its products is rapidly growing. San Miguel Food & Beverage, a food producer in the Philippines, also experienced significant gains in its stock price during the quarter. The company has restructured to bring some of its group's consumer assets into one holding company that will be relisted. We think the business will benefit from the larger scale, the stronger cash flows and a robust local customer base in the Philippines.

Notable Portfolio Changes:

During the quarter, we sold out some smaller positions in Pakistan including Habib Bank and United Bank as they experienced a tougher growth environment with the probability of rising nonperforming loans. We have also been reducing exposure to some stronger performing names, which have become expensive, and recycling the proceeds into cheaper opportunities, especially in the frontier markets.


While there is the potential for additional volatility ahead, we also see reasons to be optimistic. Potential catalysts exist for market stability and a rebound. Some countries with trade imbalances, including Indonesia, Pakistan and India, have tightened monetary policy, helping to stabilize their respective markets. In addition, relative valuations between developed markets (especially the U.S.) and Asia have widened significantly to the point where many investors are facing rebalancing needs and are reluctant to divest of their Asian and broad emerging market exposure. We believe in some instances valuations are getting very attractive, laying the foundation for considerable upside potential in emerging Asian markets, as well as in the Fund's portfolio. Across the region, economies are growing, consumers are spending and wages are rising. We will continue look for attractively valued growth opportunities in the least-developed parts of Asia.

As of 09/30/2018, the securities mentioned comprised the Matthews Emerging Asia Fund in the following percentages: Sampath Bank PLC, 2.7%; Tongda Group Holdings, 2.5%; Vinh Hoan Corp. 4.0%; and San Miguel Food & Beverage, Inc., 3.0%. The Fund held no positions in Habib Bank, Ltd. and United Bank, Ltd. 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.