Period ended March 31, 2019
For the quarter ending March 31, 2019, the Matthews Asia Value Fund returned 8.75% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned 11.45%.
The first quarter of 2019 turned out to be one of the best quarters for global markets in recent years, immediately following one of the worst quarters. The swift rebound surprised many investors. Drivers of improved sentiment included hopes for a resolution of the U.S.-China trade dispute, the U.S. Federal Reserve appearing to turn dovish after a hawkish stance a quarter ago and Chinese macroeconomic data seeming to have bottomed. While Brexit news sank global markets almost three years ago, it almost has become a sideshow even though a messy no-deal Brexit is possible. Global investors are largely focused on the U.S.-China trade dispute and seem to be sanguine over the possibility of an imminent deal.
Performance Contributors and Detractors:
The Fund lagged its benchmark by a few percentage points in a quarter when the market rose by double digits. This is understandable given the lower beta and more defensive nature of the portfolio. We might not capture all the market upside in any given quarter, but we aim to provide downside protection as well as lower volatility. In that regard, we feel good that we had only a handful of stocks that showed an absolute share price decline in the quarter, with no stock down by double-digit percentage points.
The largest detractor to performance was MPHB Capital. After a new Malaysian government came in last year, our expectation was that the regulator would approve the company's application to sell an additional 20% stake in its property and casualty insurance (P&C) business to Italy-based insurer Generali. It appears we were too optimistic. At the same time, the fundamentals in its P&C business turned south due to more intense competition. We thus substantially trimmed our position. Honma Golf, a Japanese golf club and accessory company listed in Hong Kong, was the other major detractor. In absolute terms, however, this position detracted only about 10 basis points (0.10%) from performance in the quarter. There was no apparent fundamental reason behind its share price weakness. We met with management in the quarter and came away with a favorable view of the company's long-term growth potential.
On the positive side, two Chinese domestically listed stocks, Anhui Gujing Distillery and China National Accord, were the biggest contributors to performance. Gujing is a well-known liquor brand in China and is the provincial leader in Anhui province. Anhui Gujing Distillery reported solid top-line and bottom-line growth for 2018. Gujing B-shares were trading at about 10x this year's expected operating profit, which we believe is still not excessive despite the recent run-up. China National Accord rebounded in the first quarter. It has two business lines—drug distribution and retail pharmacy—and is the market leader in drug distribution in the provinces of Guangdong and Guangxi. The company is the biggest player in retail pharmacy with more than 4,000 stores nationwide in a still fragmented market. It showed growth acceleration in the second half of 2018 as it started to put behind negative impacts from some regulatory headwinds that slowed its drug distribution business in recent years.
Notable Portfolio Changes:
We sold our position in one company in the quarter—PW Medtech Group, a Chinese medical device maker listed in Hong Kong. We bought shares of the company in early 2018. At the time, our thesis was that its roughly 16% stake in U.S.-listed China Biologic Products was worth much more than its market cap. That thesis remains true today. We believed then and now that as one of the biggest players in the structurally undersupplied industry for human plasma-derived biologics products in China, China Biologic Products is an attractive asset. We were disappointed, however, with PW Medtech's recent capital allocation decision with respect to its capacity expansion. The company also failed to address our concerns about rising accounts receivable. As value investors, valuation clearly matters to a great deal but it's far from the only thing that we care about.
Given the relatively buoyant market, we didn't find many attractive companies to invest in during the quarter. We initiated a position in Mitra Pinasthika Mustika (MPM) in Indonesia. This is our first foray into the Southeast Asian country. MPM is an automotive dealer/retailer, controlled by a family that founded Astra International, the biggest auto retailer/dealer in Indonesia. The family lost control of Astra 20 years ago during the Asian Financial Crisis and MPM remains the family's only asset in the auto industry. It runs the only Honda two-wheeler dealership in East Java. We had been following this company for the past few years but did not invest until now. While we viewed its valuation as inexpensive at below 1x book value in recent years, we were concerned about the debt on its balance sheet.
All this changed last year when MPM sold its sizeable lubricants business to ExxonMobil at a good price. The company used the proceeds to pay down debt and now its balance sheet is in a net cash position. It is rare to see a family-owned business part with a prized, organically grown asset. In addition, as part of its corporate streamlining last year, it dissolved its money-losing dealership business with Nissan and shut down unprofitable digital initiatives related to its auto business. Its market cap was not much above its net cash on the balance sheet when we initiated our position.
After a strong recovery in the first quarter, the Asia ex Japan market is near the historical high it touched about a year ago. One doesn't have to look far to see the wild swings of market psychology. China's domestic A-share market is a case in point. Toward the end of 2018, investors fled the A-share market, fearing a hard landing for the country's economy. Roughly one quarter later, investors can't seem to buy enough of the same market. This positive sentiment was further fueled by index provider MSCI's decision to boost the A-shares weighting in various MSCI indices.
Amid all this gloom followed by boom, one thing is clear: China's A-share index dropped close to 30% in U.S.-dollar terms in 2018 but the intrinsic value of the businesses in the index combined dropped far less; the index then rose close to 30% in USD terms in the first quarter of 2019 but the intrinsic value of the businesses in the index combined rose far less.
So what do we do now as value investors? I'm reminded of a quote by Warren Buffett: “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” Hence the Fund's strategy remains the same: focus on growing businesses with conservative balance sheets and run by good capital allocators; be patient and opportunistic; and invest only when the valuation discount is sufficiently compelling.
As of 03/31/2019, the securities mentioned comprised the Matthews Asia Value Fund in the following percentages: MPHB Capital BHD; 1.2%; Honma Golf, Ltd. 1.7%; Anhui Gujing Distillery Co., Ltd. 3.0%; China National Accord Medicines Corp., Ltd. 6.0%; PT Mitra Pinasthika Mustika Tbk 1.4%. The Fund held no positions in Generali, China Biologic Products Holdings, Inc., PW Medtech Group Ltd., Astra International Tbk, Honda Motor Co., Ltd., ExxonMobil Corp. or Nissan Motor Co., Ltd. Current and future portfolio holdings are subject to risk.