For the period ending June 30, 2018
For the first half of 2018, the Matthews Asia ESG Fund returned -2.08% (Investor Class) while its benchmark, the MSCI All Country Asia ex Japan Index, returned -4.65%. For the quarter ending June 30, the Fund returned -3.82% (Investor Class) while its benchmark returned -5.31%.
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-increase cycle by the U.S. Federal Reserve and a potential escalation of the U.S.-China trade war. India was a relative outperformer in the second quarter (down -0.6%) after an adverse first quarter (down about -7%), while Pakistan gave up all its strong gains (up 11%) during the first quarter and was down -20.5% during the second quarter. For the first half of 2018, Taiwan was the best performer (despite being down -0.6%), while the Philippines (down -21.2%) and Indonesia (down -18.4%) were the worst performers.
From a sector standpoint, health care, after two years of underperformance, did well during the first half of the year and was the best-performing sector (up 6.4%), while telecommunication services (down -12.2%) was the worst performer. From a currency perspective, the Japanese yen, a perceived safe haven currency, was the best-performing Asian currency (up 1.7%) for the first half of 2018, while the Indian rupee (down -6.7%) was the worst-performing currency alongside the Philippine peso (down -6.4%).
Performance Contributors and Detractors:
Stock selection in China/Hong Kong and India contributed positively and an overweight allocation to Bangladesh contributed negatively to the Fund's relative performance during the first half of 2018. From a sector standpoint, the portfolio's health care allocation and selection contributed positively as did consumer discretionary selection, while financials selection effects contributed negatively to relative performance.
At the stock level, Wuxi Biologics was the biggest contributor to Fund performance during the first half. 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.
Bank Rakyat Indonesia detracted from performance during the first half of the year. The stock sold off alongside the Indonesian equity market, which was the second-worst performing market in the benchmark. The Indonesian central bank raised the benchmark rates by 100 basis points (1%) in 2018 to defend the Indonesian rupiah. The market worried that this would have an adverse impact on the bank's net interest margins in a potentially slowing loan demand growth environment. During second quarter, the market also worried that Bank Rakyat was interested in acquiring a smaller and less profitable sharia bank, which the bank denied. We remain positive about the company's ability to continue to maintain its leadership in the profitable micro enterprise lending space over the long term and have used the share price weakness to add to our position.
Notable Portfolio Changes:
During the second quarter the portfolio added a position in Litalico, a Japanese company that specializes in providing support services to people with disabilities. Litalico has two business lines, one that transitions mental health patients into the labor market and a second one that provides assistance and after-school/day services to children with developmental problems. The company is a market leader in its businesses and drives positive outcomes for its clients. The company provides job skills to disabled people in order to prepare them to start work and Litalico also works with employers so that people can fit better within an organization's work environment and stay employed longer. It has one of the industry's highest rates of transition to regular employment and also a higher-than-industry-average six-month job retention rate of clients in the job transition business.
We exited some positions during the quarter on account of both profit-taking and also due to changes in the interest rate environment in Asia.
After a strong year of earnings growth in 2017, the prospect for continued earnings growth in Asia remains and stock valuations also remain largely 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 6/30/2018, the securities mentioned comprised the Matthews Asia ESG Fund in the following percentages: Wuxi Biologics Cayman, Inc. 3.7%; PT Bank Rakyat Indonesia Persero 3.0%; Litalico, Inc. 1.2%. 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.