For the period ending March 31, 2018
For the quarter ending March 31, 2018, the Matthews Asia ESG Fund returned 1.82% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 0.70%.
Asia's markets got off to a strong start in 2018, following a very strong 2017, but could not hold onto their gains as investors worried about a faster-than-expected rate cycle by the U.S. Federal Reserve and a potential U.S.-China trade war. Pakistan (up 11%) and Thailand (up 9%) were the best-performing markets, while Indonesia and India (down about 7% each) were the worst performers during the quarter. From a sector standpoint, health care, after two years of underperformance, did well during the first quarter and was the best-performing sector (up 9.3%), while telecommunications (down 7.2%) was the worst performer. From a currency perspective, the Japanese yen, a perceived safe haven currency, was the best-performing Asian currency (up 6%), while the Philippine peso (down 3.7%) was the worst-performing currency.
Performance Contributors and Detractors:
From a country perspective, stock selection in China/Hong Kong and India was a major driver of performance and offset the drag from negative allocation effects from an overweight allocation to India and Bangladesh. From a sector perspective, our health care allocation was a major contributor to performance, as was stock selection in materials, while an underweight allocation to information technology detracted from performance.
At the stock level, Wuxi Biologics was the biggest contributor to performance. The company is a vertically integrated Chinese contract development and manufacturing organization (CDMO) that enables cost- and time-efficient drug discovery, development and manufacturing of biologics. Wuxi Biologics plays an important role in speeding up the innovation cycle in the global biotech industry in general and the Chinese biotech industry in particular by helping both global majors as well as Chinese biotech startups through its scaled-up CDMO model. The company announced strong 2017 results and better-than-expected new customer contract acquisition, as well as faster migration of contracts into the higher value clinical trial stage from the pre-clinical trial stage.
On the other hand, Hanon Systems, a South Korea-based global auto heating, ventilation and air conditioning (HVAC) company, was the biggest detractor to performance. The company's share price came off a strong 2017 and was weak during the quarter as the market expected first-quarter operating results to be disappointing given a slow production ramp-up at one of its electric vehicle (EV) manufacturer clients. The temporary production hiccups at its client did not materially alter our view on the company's prospects as Hanon has a strong and diversified order book and continues to win new orders. We continue to like the firm's positioning to benefit from the electrification of auto industry and its ability to win orders given its strong technology and its position as an independent vendor. We used the correction as an opportunity to add to our position.
Notable Portfolio Changes:
During the first quarter, we initiated a position in Sosei, a Japanese biopharmaceutical and a drug discovery platform company. Sosei, through its subsidiary, owns a unique technology platform to help pharmaceutical firms develop drugs by stabilizing cell membrane receptors called GPCRs. The company's platform partnership with pharmaceutical companies typically involves a combination of upfront, milestone and royalty payments to Sosei. The company also has a steady stream of royalty income from out-licensed drug sales, which supports the development of its in-house drug pipeline. We find Sosei's approach to drug development attractive as it reduces risks inherent in a pure drug discovery model. The company has a diverse management team with significant representation from outside Japan—a relatively rarity in Japan. Its board has a majority of external directors (one of whom is a woman, another relative rarity in Japan).
After a strong year of earnings growth in 2017, the prospect for continued earnings growth in Asia remains and stock valuations also remain supportive. If the current trade friction between the U.S. and China escalates, however, it might adversely impact this favorable assessment. In addition, we continue to watch for signs of higher volatility, due to factors such as a strong pickup in inflation, which might cause central banks to raise interest rates or reduce liquidity much faster than expected.
We continue to be confident in Asia's ability to effectively address global ESG challenges through its leadership position in areas including electric vehicles, access to affordable health care and financial inclusion, among others. This leadership provides an encouraging backdrop for pursuing ESG-focused investing in Asia. We also find that investing in companies that are improving quality of life in Asia is a way to address the aspirations of the newly emergent and increasingly sophisticated middle class.
We also continue to employ a fundamental, bottom-up investment process and use any market dislocation in Asia as an opportunity to buy shares of what we consider to be high-quality companies with best-in-class ESG attributes at reasonable prices.
As of 03/31/2018, the securities mentioned comprised the Matthews Asia ESG Fund in the following percentages: Wuxi Biologics Cayman, Inc. 3.5%; Hanon Systems 2.1%; Sosei Group Corp. 1.4%. Current and future portfolio holdings are subject to risk.
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.