Period ended September 30, 2019
For the quarter ending Sept. 30, 2019, the Matthews Pacific Tiger Fund returned -3.94% (Investor Class), while its benchmark, the MSCI All Country Asia ex Japan Index, returned -4.39%.
Most Asian markets were down in the third quarter, following rallies earlier in the year. Political rhetoric about trade relations between the U.S. and China made frequent and unpredictable shifts, creating short-term noise and volatility in the market. Smaller companies experienced steeper price declines than larger companies in the quarter.
Chinese equities were down in the quarter, succumbing to trade-related pressures and negative sentiment. U.S.-listed Chinese ADRs were particularly weak in the quarter, creating buying opportunities for shares of high-quality companies trading at lower valuations. Hong Kong protestors remained active in the quarter and tensions between the government and protesters increased following the reporting period. Notably, we believe current valuations in China already reflect significant uncertainty, especially when compared with global peers. Indian equities fell slightly in the quarter, meanwhile, underperforming broader Asia ex Japan returns. Much of India's underperformance occurred in late July as post-election euphoria gave way to profit taking and deteriorating economic data. Late in the quarter, Indian policymakers surprised markets by announcing comprehensive corporate tax cuts and other stimulative measures.
A bright spot in the region was Taiwan, which experienced strong performance in the third quarter, as well as year to date. There is growing expectation that the Taiwanese economy may benefit from China's efforts to localize parts of the semiconductor supply chain in the region. In addition, the demand for high-end chips as necessitated by the rollout of 5G may aid some technology hardware companies in Taiwan.
From a currency perspective, most Asian currencies depreciated relative to the U.S. dollar in the quarter. The South Korean won was among the weakest (down -3.47%) on concerns over slowing global growth. In contrast, the Thai baht bucked the trend, rising slightly (up 0.27%) on the back of a current account surplus and the government's good fiscal condition.
Performance Contributors and Detractors:
On a relative basis, the Fund held up better than its benchmark during the quarter. Stock selection in Indonesia was a contributor to the Fund's relative outperformance. Indonesian hospital operator Mitra Keluarga Karyasehat, for example, generated positive absolute returns in the quarter, reflecting the ability of its management team to broaden the company's service offering. With Indonesia's government stimulating demand for health care services, the hospital operator has been expanding its offerings for lower- and middle-income health care patients.
Stock selection in South Korea also was a contributor in the quarter. South Korean search engine and internet content provider NAVER generated double-digit positive returns, even as South Korea's broader equity markets declined. The company reported stronger-than-expected results for its core business in the second quarter of 2019, noting that it expected losses at a subsidiary to have peaked. NAVER also announced it would spin off its payment platform to enhance competitiveness, and revealed plans to spin off other businesses via public offerings in the next few years.
The portfolio's underweight to Taiwan was a detractor, meanwhile, as Taiwan's equity market extended its rally in the third quarter. The benchmark's Taiwan exposure is close to 13%, while the Strategy had less than 5% exposure to Taiwan. We believe the IT hardware sector is prone to short-term cycles, which are often driven by global factors, but across-the-cycle profitability can be fairly uneven.
Looking elsewhere in the region and turning to individual stocks, DKSH Holding, a Swiss-domiciled international market-expansion services company with a focus on Asia, also was a detractor. The market priced in expectations of continued weak performance due to challenging conditions in Thailand, and the near-term headwind from internal restructuring initiated by the leadership. We have engaged with company management on their transformation process and leadership change in Thailand. Another detractor in the quarter was Chinese dairy producer Inner Mongolia Yili Industrial Group. The company reported weaker-than-expected results for the second quarter of 2019. We continue to like the company's long-term prospects, however, grounded in its commitment to food safety and its ability to offer premium products.
Notable Portfolio Changes:
During the quarter, we initiated a new position in Chinese media company Tencent Music Entertainment (TME). We like the company's dominant position in China's online music-streaming market, as well as the cash flow generation capability of its social entertainment business. There is an opportunity for the company to further its paying ratio as consumers realize the value of TME's content library.
During the quarter, we exited brick-and-mortar retailer E-Mart, primarily on the back of disappointment with its recent capital-allocation decisions. We also exited our positions in South Korean pharmaceutical maker Green Cross and Indian engineering company Thermax.
Across many parts of Asia, central bankers and policymakers are moving from being defensive to offensive, shifting the economic imperative to boosting growth. Many central banks, especially in South Asia, have aggressively cut interest rates to lower the cost of funding, and there may be more reductions in coming periods. In addition, policymakers are starting to utilize fiscal tools to revitalize growth, although the capacity to indulge in fiscal stimulus may be somewhat limited.
U.S.–China trade tensions remain unresolved, and the uncertainty is a drag on corporations' investment plans, particularly in China. The Chinese government, however, continues to balance the long-term goal of deleveraging the economy and maintaining consumption-related growth. Thus far, the government has refrained from launching broad-based measures aimed at boosting growth within the economy. While we believe the pattern of targeted relief aimed at parts of the economy may continue, we also note that policymakers have considerable ability to step in with fiscal measures, if necessary.
Elsewhere, India's economy continues to wrestle with the immediate negative impact of continued disruption in the financial system (particularly in the non-banking segment), the potential long-term benefits of corporate tax cuts and a gradual ease in the funding cycle. Indian policymakers appear willing to deploy more stimulus, but may be constrained by government budgets. Continuing economic reforms may help improve India's fiscal math. Structural initiatives such as privatization of public-sector enterprises and the opening of India's financial markets may help grow the economy over the long term and increase government tax revenues.
Amid short-term headwinds, we remain optimistic about Asia's long-term growth and development. When we travel through Asia for research, we find a genuine sense of opportunity and optimism. Another important trend across the region is the rise of entrepreneurs, who are helping to drive more sustainable and inclusive growth. We also remain excited about the growth potential in emerging parts of Asia, home to economies on the less-developed end of the spectrum. This is where we see the next generation of quality growth companies growing strong roots within Asia.
As of 9/30/2019, the securities mentioned comprised the Matthews Pacific Tiger Fund in the following percentages: PT Mitra Keluarga Karyasehat 0.9%; NAVER Corp. 4.1%; DKSH Holding AG 2.4%; Inner Mongolia Yili Industrial Group Co., Ltd. 2.5%; Tencent Music Entertainment Group 0.5%. The Fund held no positions in E-Mart, Inc., Green Cross Corp. or Thermax, Ltd. Current and future portfolio holdings are subject to change and risk.