Period ended March 31, 2020
For the quarter ending March 31, 2020, the Matthews China Dividend Fund returned -12.72% (Investor Class), while its benchmark, the MSCI China Index, returned -10.22%.
While global equities markets were in a brisk rally to celebrate the formal signing of phase one trade deal between U.S. and China, market participants had not paid significant attention to an unknown virus in central China's megacity Wuhan. No one would have expected this coronavirus, officially named COVID-19, would cause the greatest global pandemic in recent human history.
During the prolonged trading suspension period of China's domestic A-share market due to the Lunar New Year holiday and COVID-19, Hong Kong markets had already started to negatively react to the economic consequences of various lock down measures taken by the Chinese government. Sectors sensitive to people movement such as tourism, restaurant and offline entertainment have been hit hardest. After the A-share market resumed trading on February 3, it experienced a one day heavy selloff, but started to recover strongly as the infection situation in China started to show signs of stability. As the virus started to heavily hit European countries, causing tremendous pressure on global economic growth, Chinese equities started to decline again, led by export-oriented industries such as textile, electronic goods.
On March 8, 2020, Saudi Arabia initiated oil price war with Russia, which triggered serious concerns on the U.S. shale oil industry and U.S. high yield credit spread spiked as a result. This development, together with rapid growing COVID-19 infections in the U.S., caused sharp selloffs in U.S. equities. The Federal Reserve quickly cut interest rate to zero to boost the ailing economy, and later on March 23, the Fed announced unlimited quantitative easing to purchase Treasury and mortgage-backed securities to support financial markets; global equities markets saw their bottom from that point.
Performance Contributors and Detractors:
During the quarter, our holdings in the consumer discretionary sector were the top detractors to the Fund's performance. Names including Geely Automobile and Gree Electronic Appliance experienced a significant decline in their share prices, as concerns regarding a broad-based, global manufacturing shutdown mounted due to the virus impact and weakening consumer spending on discretionary items.
As for our top performance distractor during the quarter, China Suntien Green Energy, we would categorize it as a truly special situation. After the company reported healthy profit growth for 2019, China Suntien cancelled its dividend payment, triggering a severe selloff after the disappointment. However, we learned from company management that the decision to cancel its dividend payment was solely intended to speed up China Suntien's dual listing process in Chinese A-share market. The A-share listing could happened in the second half of 2020, and management intends to make up the missed dividend payment right after the listing. With experience of similar cases in the past, we believe their rational, and took the opportunity to add into our position.
On the other hand, among the top contributors to the Fund's performance was our holding in Hope Education Group, a private operator of higher education institutions in China. Hope Education's revenue had very limited impact from the COVID-19 outbreak as much of the tuitions were pre-collected. In addition, the company reported strong 2019 earnings. The Fund's second largest contributor was Sun Art Retail Group, one of the largest hypermarket operators in China. The company witnessed a demand surge for its hypermarket business, as Chinese consumers were stocking up food and other daily necessities during the coronavirus outbreak in China. The strict, stay-at-home quarantine measures adopted in China gave rise to the various online e-commerce retailing businesses, including Sun Art's online grocery delivery business. Sun Art's share price delivered a double-digit, positive return despite the broad market sell-off.
Notable Portfolio Changes:
During the quarter, we initiated a new position in Livzon Pharmaceutical Group. Livzon is one of the oldest privately owned pharmaceutical companies in China with diversified products across various medicines. During the first quarter, Livzon announced a new employee incentive plan with emphasis on both healthy profit growth and healthy dividend payout ratio, which we believe is rare among China's pharmaceutical industry.
In light of the potential speed up of 5G telecom infrastructure investment in China, we switched our holding in China Unicom to China Tower Corporation. Our original investment thesis on China Unicom was based on its joint development with China Telecom on 5G which could reduce its CapEx spending on 5G rollout. However, given that 5G infrastructure investment is now included in the government's stimulus program, we sold our postion to fund the purchase of China Tower. We believe the telecom tower company will benefit more directly if telecom carriers such as China Unicom and China Telecom add more wireless base stations onto its tower without much incremental cost.
During the market selloff, we exited Yixintang Pharmaceutical Group, JNBY Design and Nissin Food due to our reduced conviction of their long-term growth potential, while using the proceeds to add to our holdings where we have stronger conviction.
Although the Chinese economy has recovered from the worst phase of the virus outbreak thanks to some draconian measures adopted by the government (as of this writing, Wuhan, the original epicenter has reopened and reconnected with other parts of China), Chinese companies are facing strong near-term earnings headwind, caused by the sudden supply side disruption initially and demand side shock later on.
However, as China's economy has transformed from being export led to one that is now consumption led, the recovery of Chinese corporates' earnings could still be much faster than other major markets, as people's lives come back to normal sooner than other parts of the world. In addition, the valuation of Chinese equities is still lower than U.S. equities, even after the recent outperformance. Thus, we believe Chinese equities are still very attractive for long-term investors.
As of March 31, 2020, the securities mentioned comprised the Matthews China Dividend Fund in the following percentages: Geely Automobile Holdings, Ltd. 2.3%; Gree Electric Appliances, Inc. of Zhuhai A Shares 2.8%; China Suntien Green Energy Corp., Ltd. H Shares 1.6%; Hope Education Group Co., Ltd. 4.3%; China Merchants Bank Co., Ltd. H Shares 3.0%.
The Fund held no positions in Yixintang Pharmaceutical Group Co., Ltd. A Shares, JNBY Design, Ltd., or Nissin Foods Co., Ltd. Current and future portfolio holdings are subject to risk.