Matthews Asia ESG Fund


For the period ending December 31, 2018

For the year ending December 31, 2018, the Matthews Asia ESG Fund returned -9.73% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned -14.12%. For the fourth quarter, the Fund returned -6.58% (Investor Class) versus -8.60% for the Index. 

Market Environment:

The full range of market emotions was on display in Asia in 2018—from expectations of a “melt-up” in early 2018 and midyear worries about a meltdown due to U.S.-China trade tensions, to fewer worries amid signs of a thaw in trade tensions toward year end. 2018 was also the year of a strong U.S. dollar. All major Asian currencies except the Japanese yen (up 2.7%) and Thai baht (up 0.1%) depreciated against it, with the worst-performing currencies being in South and Southeast Asia (Indian rupee down 8.5%; Indonesian rupiah down 5.7%). 

Pakistan and South Korea were the worst-performing markets during the year, while Thailand and Malaysia held up reasonably well in a difficult year for Asia. Utilities was the best-performing sector, while consumer discretionary was the worst-performing sector.

Performance Contributors and Detractors:

Most of the outperformance in 2018 was generated from stock selection. At the country level, China/Hong Kong were the biggest contributors to relative performance, while Vietnam and the Philippines slightly detracted from performance. From a sector standpoint, consumer discretionary and information technology were the biggest positive contributors, while financials detracted the most 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 continued to execute well on its strategic plan and experienced faster migration of contracts into the higher value clinical trial stage from the pre-clinical trial stage. 

On the other hand, Inner Mongolia Yili was the biggest detractor from performance. Yili's performance was in line with that of the weak China A-share market performance as investors worried about the impact of the U.S.-China trade friction, alongside the impacts of the deleveraging campaign and the property-market cooling efforts by the Chinese government on China's economy. From a fundamental standpoint, the company executed well, with the impact of higher raw material prices somewhat offset by an improving product mix. We continue to like Yili's long-term business prospects and added further to our position during 2018.
 

Notable Portfolio Changes:

During the fourth quarter, the Fund initiated a position in Unicharm, a Japanese personal care company that focuses on baby diapers, feminine care products and adult incontinence products. Unicharm is Asia's largest and the world's third-largest company in the disposable hygiene category. The company has a dominant position in Japan's adult diaper market and is poised to benefit from aging populations and rising life expectancy in other parts of Asia. Unicharm also has market-leading positions in baby diapers and feminine hygiene products across several Asian markets. The company has strong environmental programs to reduce its footprint and has a plan to achieve 100% third-party certification of paper and pulp, a key raw material, by 2020. The company is also in the process of commercializing a diaper recycling system that should materially reduce the raw material intensity of the business over time. Unicharm is focused on shareholder returns and has a 50% total return (dividends and buybacks) policy.
 

Outlook:

U.S.-China trade friction, which escalated sharply up until the G20 summit meeting in Argentina in November, seems to be de-escalating but we continue to monitor progress very closely. We believe China has the ability to at least partially address the shorter-term drag on growth by way of stimulus. And the broad contours of such stimulus are slowly taking shape in the form of targeted infrastructure investments, reduced banking reserve requirement ratios and tax relief. Also, we are watching for sharp oil price movements that could impact the current account balances of South and Southeast Asian countries, with implications for their currencies.
 
The recent sell-off has selectively provided attractive entry opportunities in Asia and we continue to employ a fundamental, bottom-up investment process and use any further 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.

We are 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 ESG-focused investing in Asia. We also find that investing in companies that are improving the quality of life in Asia is a way to address the aspirations of the newly emergent and increasingly sophisticated middle class.

 
As of 12/31/2018, the securities mentioned comprised the Matthews Asia ESG Fund in the following percentages: Wuxi Biologics Cayman, Inc. 1.5%; Inner Mongolia Yili Industrial Group Co., Ltd. 4.2%; Unicharm Corp. 3.0%. 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.