Matthews Emerging Markets Equity Fund
Period ended June 30, 2020
The Matthews Emerging Markets Equity Fund was launched on April 30, 2020. Since inception, the Fund returned 16.70% (Investor Class), while its benchmark, the MSCI Emerging Markets Index, returned 8.25% over the same period. This is the first commentary for the Matthews Emerging Markets Equity Fund.
The first half of 2020 has been like no other. The expansion of the COVID-19 around the world led to a dramatic selloff across most asset classes in March and a dash into USD cash. Market volatility exceeded the levels seen during the 2008 Global Financial Crisis. Emerging markets were no different as many currencies, country indices and individual company stock prices moved up over the course of the second quarter. As investors gained confidence that the plumbing would not break, the selloff abated and markets began to recover from their March lows. Within emerging markets, the first part of the year saw very strong relative performance from China, but the rebound since the bottom has been led by other markets that were particularly hard hit. While volatility—as measured by the Chicago Board Options Exchange's CBOE Volatility Index—has come down, we remain quite cautious as asset prices remain high and the duration and economic damage of the pandemic remain hard to dimension.
Year-to-date, the Shanghai Composite Index led most major emerging market country indices, followed by Taiwan. While the aforementioned were slightly negative year-to-date, the return was roughly in line with the S&P 500 Index. Russia, Mexico, Brazil, India and much of Southeast Asia remain down more than 10% in U.S. dollar terms year-to-date.
Market dislocations allowed us to invest in high conviction companies at what we believe are compelling valuations as we built the portfolio. We believe constructing an emerging markets portfolio designed for sustainable growth requires identifying companies that have higher growth metrics, as well as higher quality metrics, than the broader market. Good companies worldwide share common traits. They require a strong competitive position and the ability to allocate capital well. We tend to focus on companies that can serve the needs of domestic consumer within their markets, although we may invest in commodities and companies that serve a global marketplace. We also tend to look for companies that can withstand economic cycles. In addition, the Fund's portfolio management team takes an all-cap approach, believing that smaller cap companies may offer attractive potential for generating alpha.
Contributors and Detractors:
The Fund outperformed its benchmark since its inception on April 30, 2020 through June 30, 2020 driven by strong stock selection. During the reporting period, our largest positive attribution came from China/HK, followed by Brazil and Russia.
From a sector standpoint, consumer staples and discretionary sectors were contributors to absolute performance but slight detractors from relative performance. However, this was more than offset by very strong relative attribution in other consumer facing sectors like communication services, where our holdings tend to be concentrated in media and entertainment. The Fund takes a holistic approach to considering consumer behavior and increasingly digitally driven behavior. Companies that do similar things can often be classified differently. Alibaba and Sea Ltd, for example, are both e-commerce companies yet one is classified as consumer discretionary and the other as communication services. We focus less on classifications and more on how and where companies make money. Our holdings are the natural outcome of our bottom-up stock selection process.
Notable Portfolio Changes:
The Fund added to its overweight in software over the reporting period by increasing position sizes in existing holdings and starting a position in Livechat, a Polish software company. Health care has been an increasing focus for the Fund, and we currently maintain seven positions in the sector—three in China/HK, one in South Korea, one in India, one in Brazil and a company listed in the U.S. whose largest market is China. While we are (or have been) cautious in the financials sector, we have increased our exposure during the reporting period.
Media coverage of the ongoing health pandemic of COVID-19 has been intense. Very few people alive have lived through something similar, and the scope of every economy being impacted is without recent precedent. All companies, too, have been impacted. For some, this has been an acceleration of trends that were in place and the pandemic appears to have improved their long term business prospects. For others, the pandemic has decreased line of sight on strategy or end demand. It is far too early to predict with certainty the near-term or long term impacts of a global event like the one we're all living through.
Experiences both at the company and country level have been highly heterodox. In China, the disease hit before the economic lockdown and we're seeing some green shoots. In much of emerging markets, the lockdown hit before the disease. Some, like South Korea, appear to have managed the pandemic well. Others, like Brazil, are still seeing increases in cases. Similarly, fiscal budgets and monetary responses have varying amounts of firepower across emerging markets. Many of the EM geographies are quite constrained versus the G3 (U.S., Europe, and Japan) in terms of the fiscal or monetary expansions that they can proffer without detrimental impact to currencies or local market conditions. Political tensions, too, remain elevated. China's relationship with the U.S. is a focus for many investors, as is China's engagement with other emerging markets geographies like India.
We do not pretend to have more clarity on such macro events. For the Matthews Emerging Markets Equity Fund, our philosophy starts at the company level and we believe the attributes of great companies are similar across geographies. The heightened uncertainty of the pandemic has accentuated our focus on quality balance sheets and business model. We remain cautious on banks in a world of low rates and loose government balance sheets. History has often shown that the best time to pick up great assets may be in times of great stress. While we are very concerned about the global pandemic and its social and economic impacts, we are optimistic about the long-term prospects of our holdings.
As of 6/30/20, the securities mentioned comprised the Matthews Emerging Markets Fund in the following percentages: Alibaba Group Holding, Ltd. ADR, 6.8%; Sea Ltd ADR, 1.2%; Livechat Software SA, 2.0%. Current and future holdings are subject to change and 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.