Matthews Asia ESG Fund

For the period ending March 31, 2019

For the quarter ending March 31, 2019, the Matthews Asia ESG Fund returned 12.02% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 11.45%.

Market Environment:

Asian equity markets rebounded strongly in the first quarter of 2019 after a weak 2018 performance. Many Asian currencies appreciated vs. the U.S. dollar, particularly the Thai baht (up 2.6%) and the Chinese renminbi (up 2.5%), while the Japanese yen (down 1.1%) and the South Korean won (down 1.7%) depreciated against the U.S. dollar.

Chinese equity markets (up 17.2%) posted some of the strongest results in the region, as easing trade tensions and a gentle shift in Chinese monetary and fiscal policy supported local sentiment. Taiwan, Pakistan and the Philippines also generated attractive gains in the quarter. Meanwhile, equity prices in Japan (up 6.9%) rose, but trailed behind emerging and frontier markets.

Across the region, the consumer discretionary and real estate sectors were all strong performers. In contrast, the utilities and health care sectors lagged the broader market rally.

Performance Contributors and Detractors:

Stock selection in China was the largest contributor to performance in the quarter, while asset allocation to Japan was the biggest detractor. From a sector perspective, the Fund's holdings in industrials and financials were strong contributors to performance, primarily due to stock selection. The Fund's holdings in consumer discretionary and real estate were detractors due to a combination of being underweight these sectors relative to the benchmark and stock selection.

Inner Mongolia Yili Industrial Group, China's largest dairy company, made a strong contribution to performance, recovering from an earlier bout of volatility in its stock price in 2018. With a solid business model and increasingly international footprint, Yili benefits from the rise in income among Asia's middle-class consumers, who prioritize food quality and safety from trusted brands. The company also is benefiting from consumers' interest and willingness to buy more premium dairy products. The company is listed in China's domestic stock market, known as A-shares, and may also have benefited from growing awareness of index provider MSCI's rising inclusion of A-shares in its global indexes.

A detractor from performance was Tsukui, an elderly day care operator in Japan. The company's latest quarterly results (especially sales growth) disappointed some as there was an increase in the competitive intensity in the sector in the aftermath of the periodic government price revision. We see the company as a market leader, however, especially in providing medium- to high-level care services and individualized functional training services and as a consolidator in a fragmented industry with attractive long-term prospects. We added to our position during the quarter. Day care offers a cost-effective elderly care solution, especially as the Japanese government looks to control health care costs.

Notable Portfolio Changes:

During the quarter the Fund initiated a position in UT Group in Japan, a leading worker dispatch and outsourcing business focused on the Japanese manufacturing sector. The company's approach to business is different from a typical dispatch model of sending an individual worker to a client's workplace. UT Group engages in a “team dispatch” model where they send a team onsite after receiving a contract to manage a whole production line owned by a customer.

We believe UT Group's model leads to better outcomes for the firm, their employees and their clients. The team-based approach leads to superior workplace assimilation, better skills upgrading leading to higher productivity and ultimately much lower employee turnover (a third of industry average). The company's highly innovative business model is well-positioned to benefit from a tight Japanese labor market as well as tightening labor regulation in Japan.

During the quarter, we exited Bharat Financial Inclusion, an Indian nonbank financial company, which is in the process of being acquired by another portfolio holding, IndusInd Bank, a Mumbai-based commercial bank. We reallocated the proceeds from the sale of Bharat Financial Inclusion and added to our IndusInd position.


Sentiment seems to have improved following easing trade tensions between the U.S. and China, as well as minor, incremental use of stimulus by Chinese policymakers and a dovish outlook from the U.S. Federal Reserve. At the same time, the broader macroeconomic outlook for the region as well as the world remains somewhat muted. The market is not as cheap as it was a quarter ago but we continue to look for opportunities that may arise from market dislocations.

Quality-of-life concerns are becoming increasingly important for Asia's middle class and will drive demand for consumer products and services that address issues such as air and water pollution, financial inclusion, access to affordable health care and product safety. We believe these developments create attractive investment opportunities. We will continue to engage with companies by leveraging Matthews Asia's extensive research capabilities and our deep understanding of ESG issues in the region.

As of 3/31/2019, the securities mentioned comprised the Matthews Asia ESG Fund in the following percentages: Inner Mongolia Yili Industrial Group Co., Ltd. 4.5%; Tsukui Corp., 2.0%; UT Group Co., Ltd. 1.2%; IndusInd Bank, Ltd. 2.8%. The Fund held no position in Bharat Financial Inclusion, Ltd. Current and future 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.