Matthews China Dividend Fund
Period ended March 31, 2018
For the quarter ending March 31, 2018, the Matthews China Dividend Fund returned 1.93% (Investor Class), while its benchmark, the MSCI China Index, returned 1.82%.
China's equity markets experienced another roller coaster ride during the first quarter of 2018, reminding investors of the volatile nature of this market. Chinese equities were strong in January, but quickly ran out of steam in February as the U.S. 10-year Treasury bond yield increase caused a global sell-off in equity markets. Strong financial results reported by internet giants Tencent and Alibaba Group also led investors to scrutinize the declining margins at these leading firms. The quarter also saw the end of term limits for the Chinese presidency. Shortly afterward, any political concerns were accompanied by a return of trade tensions between Washington and Beijing.
Performance Contributors and Detractors:
During the quarter, the Fund's holding in Chinese insurance brokerage firm Fanhua was a top contributor to performance. Over the past two years, Fanhua's management successfully restructured its insurance distribution business mix, and moved away from low-margin auto insurance to focus more on growing its life insurance distribution business. It has especially concentrated on protection-type products, which carry higher margins and for which the underlying commission income is more frequently recurring. With these changes Fanhua's profitability began improving significantly. Since the insurance distribution business is capital-light and does not bear underwriting risk, Fanhua's ability to pay higher dividends is also enhanced with improving profitability. The company recently announced a new dividend policy that raised its minimum dividend payout from 30% to 50%, and instituted a quarterly dividend payment schedule.
Conversely, Sinopec Kantons, an energy infrastructure company, was among the top performance detractors during the quarter. The company announced strong earnings growth of 20% for 2017, but its stock price fell sharply after the earnings release due to its weaker-than-expected second half results. We are closely watching the new gas pipeline tariff the company was subject to in the last quarter of 2017, which led to lower profitability. We still believe management can improve profitability within the framework of the new tariff.
Notable Portfolio Changes:
During the quarter, we added a position in Shanghai Baosight Software, which provides IT software services in China. We are glad to see the firm's industrial software development business benefiting from the increasing profitability of Chinese steel mills, which are placing a higher priority on automation. As the largest software vendor in this segment, Baosight is seeing strong growth in its orders. In addition, its data center business, which utilizes empty land at vacant steel mill plants, has begun to contribute significantly to revenue and profits. More importantly, the company finally adopted a stock-based incentive program to better align management and shareholder interests.
During the quarter, we exited a few positions, including China Everbright and Tarena International, which were facing structural challenges that impacted their earnings and dividend growth. We decided to redeploy capital elsewhere.
Currently, the strong fundamentals and attractive valuations for companies in China are being overshadowed by market concerns over a potential U.S.-China trade war. If not averted, this trade tussle could have broader economic and geopolitical implications. In terms of our strategy, we believe it is prudent to increase the portfolio's defensiveness by increasing our weight of high dividend-yield stocks with stable underlying cash flow to balance the portfolio's exposure to dividend growth names. While near-term market conditions could remain volatile, we believe China already has transformed its economy into one led by consumption growth rather than export-driven growth. Any potential sell-off would increase the attractiveness of companies that can sustain and grow their earnings and dividends in this environment. We continue to seek these types of compelling opportunities.
As of 3/31/2018, the securities mentioned comprised the Matthews China Dividend Fund in the following percentages: Tencent Holdings, Ltd. 5.7%; Fanhua, Inc. 2.4%; Sinopec Kantons Holdings, Ltd. 1.4%; Shanghai Baosight Software Co., Ltd. 1.8%. The Fund held no positions in Alibaba Group Holding, Ltd.; China Everbright, Ltd. or Tarena International, Inc. Current and future portfolio holdings are subject to risk.
There is no guarantee that a company will pay or continue to increase dividends. Past performance is no guarantee of future results.
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.