Period ended March 31, 2018
For the quarter ending March 31, 2018, the Matthews Asia Growth Fund returned 5.58% (Investor Class), outperforming its benchmark, the MSCI All Country Asia Pacific Index, returned 0.04%.
Equities across Asia's emerging markets began the quarter with a strong start. However, by the middle of the quarter, volatility in global equity markets picked up significantly. Despite the volatility, equity markets in China, Pakistan, Thailand, Malaysia and Taiwan ended the quarter with positive returns. Meanwhile, markets in India, the Philippines, Indonesia and Australia ended the quarter with negative returns.
Japan's equity markets ended the quarter at approximately the same level at which they started the year on a U.S. dollar basis. Though equity prices did decline on a local currency basis, a significant gain by the yen versus the dollar offset those declines. In addition to experiencing reverberations from the volatility in global equity markets, Japan's markets also were impacted by local news. Prime Minister Shinzo Abe and his wife were plagued by allegations of cronyism in connection to a discounted sale of state-owned land to a private school. This resulted in a sharp decline in his approval ratings.
On a sector basis, a bright spot across many Asian economies has been health care. Demand for health care services is growing across the region's frontier, emerging and developed markets. Leadership in the health care sector is currently coming from China's biotech companies, which are conducting advanced research and clinical trials, as well as from a handful of biotech firms in Japan. We've also seen significant growth in medical technology companies that serve health care professionals and medical-related businesses.
Performance Contributors and Detractors:
The Fund outperformed its benchmark during the quarter. The five largest companies by market capitalization in the index experienced stock price declines amid market volatility. Since we employ an active approach to portfolio construction, our Fund typically looks very different from the benchmark by design and we do not hold those top-five index constituents. Rather, we tend to invest in more consumer-driven and less cyclical sectors than the benchmark as a whole. In addition, a general weakness in the U.S. dollar and favorable appreciation among many of Asia's currencies added to our positive performance.
Four out of the top five contributors were health care names, led by Wuxi Biologics Cayman of China. Among many up-and-coming biotech names in China, we believe Wuxi shines brightest in terms of its sound business model. Rather than relying on a single “hit-or-miss” product, the company is one of the most sought after drug discovery outsourcing companies in the world with many global large pharmaceutical companies as clients. The only non-health care name in the top five was Baozun, a Chinese e-commerce company. It continued expanding its operating margin from a mid-single digit to a low double-digit level in the last 12 months due to a shift to a more profitable service-based model, which does not bear the burden of carrying inventories.
Meanwhile, our position in PC Jeweller, a jewelry manufacturer in India, was our biggest detractor from performance during the quarter. The company experienced a sharp stock price correction in the first quarter on rumors of a stock-price manipulation scheme. While these rumors seem unsubstantiated, we will monitor the situation and continue to evaluate the strength of the company's management team. The second-largest detractor was Seria, a Japanese dollar-store chain that offers most items priced at 100 yen. The company has recently suffered from weak same-store sales and rising labor costs. We believe, however, that the company remains strong and ambitious, with favorable prospects for the long haul.
Notable Portfolio Changes:
We initiated two new positions during the quarter: Harmonic Drive Systems of Japan, and BeiGene of China. Harmonic Drive Systems manufactures and sells precision actuators and controllers. The thesis behind this company is related to Japan's prominence in automation and robotics; the company has a dominant market share in the smaller-sized “speed reducer” components that are a key component for industrial robots. Having researched and followed this company for a considerable amount of time, we took advantage of new share offerings related to its planned multi-year capacity expansion program to initiate a position.
BeiGene is a clinical stage biopharmaceutical company that focuses on innovative cancer treatments. We see BeiGene as one of the best-positioned oncology-focused biotech companies in China. The company is expected to file a “PD-1 inhibitor” cancer drug this year, and this process is likely to be expedited by the China Food and Drug Administration. PD-1 inhibitor therapies seek to enable a patient's own immune system to identify and attack cancer cells. We also exited our positions in Kakaku.com Inc., Taisun International Holdings and trimmed our position in Vista Land & Lifescapes this quarter.
News of trade conflicts picked up again during the quarter. If trade issues spin out of control, they would be negative for global growth and global equities. To date, however, we have seen very measured responses from China. At the Davos World Economic Forum in January, Liu He, China's top economic advisor to President Xi Jinping, made public comments that suggested strong support to global trade. Meanwhile, corporate earnings across Asia have been improving over the last 12 to 18 months. Earnings growth, which started with cyclical sectors, such as information technology, is now expanding to a broader range of sectors.
Election cycles will pick up over the next two years in many parts of Asia, including India, Indonesia, Malaysia, Taiwan and the Philippines. Elections have the potential to create market volatility. At the same time, incumbent governments tend to increase spending during election cycles, which can be supportive of underlying fundamental demand and provide further support to earnings improvement. Asia's regions have many different growth drivers, but common threads tend to include rising incomes and increased consumer spending. As always, we will continue to look for companies with strong profits, strong growth and a competitive edge within their respective industries.
As of 03/31/2018, the securities mentioned comprised the Matthews Asia Growth Fund in the following percentages: Wuxi Biologics Cayman, Inc. 3.4%; Baozun, Inc. 3.5%; PC Jeweller, Ltd. 1.7%; Seria Co., Ltd. 2.2%; Harmonic Drive Systems, Inc., 1.4%; BeiGene Ltd., 1.2% and Vista Land & Lifescapes Inc., 0.4%. The Fund held no positions in Kakaku.com, Inc. or Taisun International Holding Corp. Current and future portfolio holdings are subject to risk.