Matthews Asia Value Fund


Period ended September 30, 2018

For the quarter ending September 30, 2018, the Matthews Asia Value Fund returned -0.16% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, fell -1.45% over the same period.

Market Environment:

The U.S.−China trade war, rising interest rates and depreciating emerging markets currencies dominated the news in the third quarter. The trading spat escalated with no end in sight. This has resulted in many companies in China either delaying capital expenditure or considering moving manufacturing operations outside of China. It remains to be seen how this will impact the Chinese economy over the medium term. Divergence in stock market performance between the U.S. and emerging markets was stark in the quarter. The U.S. market shrugged off trade war-related concerns and reached fresh highs. The Asia ex Japan market, meanwhile, dropped -1.45% in U.S. dollar terms.

Performance Contributors and Detractors:

Two big contributors to performance in the third quarter were CK Hutchison Holdings in Hong Kong and Samsung SDI in South Korea. CK Hutchison is a well-known conglomerate that was founded by Li Ka-Shing. Samsung SDI is a Samsung Group affiliate and one of the world's biggest electric-vehicle battery makers. Shares of both companies rose nearly 10% in the quarter in a down market. Both reported earnings in the quarter but nothing remarkable in our opinion. We were not aware of any notable news for either company.

The biggest detractor in the quarter was Yamada Consulting in Japan. The management consulting company was a top performer in the portfolio in the past year. It reported weak earnings, however, for its fiscal year Q1. Top-line year-over-year comparison was difficult in the quarter due to an unusually big order booked a year ago. On the cost side, it had some upfront costs incurred due to the hiring of a data scientist team in order to boost its consultants' productivity. It expects profit to pick up in the rest of the fiscal year.

Clear Media also was a detractor to performance in the quarter. Trading remains suspended for shares of Clear Media, the largest bus shelter advertising company in China, due to a past incident where a few junior-level employees misappropriated US$12 million (77 million Chinese renminbi) of company funds a long time ago. We commented on this company extensively in the past few quarters. During the third quarter, Clear Media reported reasonable first-half 2018 numbers. We consider its results somewhat neutral. The company is in the final stage of implementing remediation measures recommended by an independent investigation committee to tighten its internal processes. Once this is completed, we believe the company will have satisfied all the trading-resumption requirements set by the Hong Kong stock exchange.

Notable Portfolio Changes:

We took advantage of market volatility in the quarter to consolidate the portfolio down to fewer companies. We sold several of the smallest positions and made the rest of the portfolio more concentrated. This is part of our effort to upgrade the overall quality of the portfolio by concentrating our assets in companies in which we have the highest conviction. The number of companies in the portfolio was close to 40 at quarter end. We expect this number to range between 40 and 50 over time.

During the quarter we initiated a position in Naspers, a South-Africa-based media conglomerate. It owns a 31% stake in Hong Kong-listed Tencent. Tencent is one of the biggest internet businesses and operates QQ and WeChat, the dominant messaging apps in China. Naspers' share price fell in the quarter after Tencent reported weak earnings due to softness in its gaming segment. Naspers' stake in Tencent is now worth about 30% more than its market cap. It also owns stakes in other fast-growing internet businesses globally that we believe are worth approximately US$20 billion. We effectively bought Tencent at around 15x P/E ex cash through Naspers, a compelling valuation for a dominant franchise, even after taking into account a proper holding company discount.  

Since inception of the Fund, we have largely stayed away from companies in India due to valuation concerns. In the quarter, we initiated a position in Wipro, one of the biggest IT service providers globally based out of India. It is one of the big three players in India along with Infosys and Tata Consultancy Services (TCS). Among the three, it was commonly considered the weakest in terms of delivery capabilities. A few factors attracted our attention: 1) a new CEO came from TCS two years ago and, based on recent operating metrics, we believe he has put Wipro on the right profit growth path; 2) Wirpro's operating margin declined from 20% four years ago to 15% last year, substantially below its peers and below its potential. We believe its margin has bottomed; 3) Wipro's share price was weak earlier this year despite significant Indian rupee depreciation. We initiated our position at a share price in the low-teens times free cash flow (FCF) ex cash.

Outlook:

The quarter marked 10-year anniversary of the Lehman Brothers bankruptcy that sparked the Global Financial Crisis. Late 2008 and early 2009 was a period of opportunity for value investors since so many great businesses with solid balance sheets were trading at cheap valuations. It was certainly a time to be greedy when others were fearful, though few acted on it at the time.

As volatility has returned lately in the markets in which we invest, we have been asked a lot about how we seek to mitigate volatility. We embrace volatility because without it we could not buy low and sell high. We like to take advantage of volatility to upgrade the quality of the portfolio in reaction to bad news by buying good businesses at a depressed multiple on top of a depressed earnings base. So aiming to mitigate volatility for us contains four ingredients: sticking to or upgrading quality; acting only in reaction to temporary bad news; buy at a depressed earnings multiple; and making sure earnings are depressed or at least not above the trend line.  

As of 09/30/2018, the securities mentioned comprised the Matthews Asia Value Fund in the following percentages: CK Hutchison Holdings, Ltd. 5.8%; Samsung SDI Co., Ltd. 5.3%; Yamada Consulting Group Co., Ltd. 2.5%; Clear Media, Ltd. 6.0%; Naspers, Ltd. 1.6%; Wipro, Ltd. 0.7%. The Fund held no positions in Tencent Holdings Ltd., Infosys Ltd., or Tata Consultancy Services, Ltd. 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.