Period ended September 30, 2019
For the quarter ending Sept. 30, 2019, the Matthews China Fund returned -5.58% (Investor Class), while its primary benchmark, the MSCI China Index, returned -4.67%. The Fund's secondary benchmark, the MSCI China All Shares Index, returned -3.93%.
Chinese equities were down in the third quarter, succumbing to trade-related pressure and negative sentiment. U.S.-listed Chinese ADRs were particularly weak amid U.S—China trade tensions. Although the near-term outcome of trade negotiations remains unpredictable, a slowing U.S. economy could put pressure on U.S. President Donald Trump to negotiate as U.S. elections draw closer.
Meanwhile, Hong Kong protests and tensions continued. Looking back to an earlier protest, the umbrella movement of 2014 lasted for several months, so current protests could take time to subside. Notably, the portfolio has limited exposure to companies directly impacted by the protests. Hong Kong protests continued to be prominent in global headlines, contributing to negative sentiment among foreign investors.
On a positive note, domestically listed Chinese stocks, known as A-shares, generated attractive gains year to date, even as returns for Chinese stocks listed in Hong Kong were essentially flat for the same period. The notable divergence in returns indicates a more positive mindset among mainland Chinese investors toward local economic conditions, where domestic consumption remains healthy and continues apace.
Performance Contributors and Detractors:
From a sector perspective, the Fund's holdings in the financials, communication services and consumer discretionary sectors detracted from relative performance. A detractor among individual stocks was Ctrip.com International, a travel booking site. Weakened sentiment on outbound travel from mainland China to Hong Kong and Taiwan due to the Hong Kong protests and government restrictions on individual travel to Taiwan dampened the company's near-term growth prospects. However, we continue to like the company's long-term prospects. Increased demand for travel services is a long-term, secular trend in China and Ctrip continues to diversify its revenue sources in catering to both increasing domestic as well as global travel among Chinese consumers.
Turning to contributors, the Fund's holdings in the health care, information technology and consumer staples sectors contributed to performance. A contributor among individual stocks was Sino Biopharmaceutical, a leading pharmaceutical drug manufacturer in China. Despite the government's push for affordable health care and the overhang of price cuts in generic drugs, Sino Biopharmaceutical has been executing well in terms of diversifying and enhancing its product mix to include more innovative oncology drugs, which have shown considerable growth. The company also has increased its spending on research and development in past years, and we believe it has built a sufficiently strong pipeline to capitalize on the growth of innovative drugs in China in the years ahead.
Notable Portfolio Changes:
During the quarter, we initiated a new position in Wuxi Biologics, a leading global biologics services provider to multinational pharmaceutical and biotechnological companies. Wuxi develops and manufactures antibody drugs and biological medicines and provides research material generation, sterility assurance programs, clinical trials and translational oncology research services. We like its ability to grow market share by competing in innovation and intellectual property.
We also initiated a position in China East Education, a vocational training company based in the eastern provincial capital of Hefei. The company operates schools that train graduates to work in services-based industries, such as food preparation, information technology support and auto-repair services. As services continue to make up the largest part of China's economy, we believe demand for skilled workers in these areas will rise.
During the quarter, we exited several smaller positions while streamlining the portfolio in favor of higher-conviction positions. Companies we exited included semiconductor equipment maker ASM Pacific Technology; fiberglass manufacturer China Jushi; petroleum refinery China Petroleum & Chemical; diary producer Inner Mongolia Yili Industrial; employee recruiter 51Job; and laminate producer Kingboard Holdings. We also exited some streaming media and entertainment companies, including iQiyi, Tencent Music Entertainment, and YY.
Following the reporting period, sales figures during China's semiannual holiday of Golden Week looked resilient as consumers continued to make upgrades in purchases. Domestic tourism remained robust and hotel bookings were up among travelers visiting family members within mainland China. Restaurant revenues also were up during the holidays, another sign of healthy consumer spending.
Meanwhile, U.S.–China trade tensions remain unresolved. The Chinese government 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 fiscal ability to step in, if necessary.
Domestic consumption and the growing services sector within China remain the primary drivers of China's growth. We see significant consumption growth coming from China's less-developed urban centers, which are often home to millions of inhabitants per city who have rising incomes and a strong interest to upgrade their quality of life. Our portfolio construction process, designed to identify the most compelling opportunities from the bottom up, will continue to look for quality growth companies with attractive, long-term secular growth potential.
As of 09/30/2019, the securities mentioned comprised the Matthews China Fund in the following percentages: Ctrip.com International, Ltd. 1.4%; Sino Biopharmaceutical, Ltd. 2.9%; Wuxi Biologics Cayman, Inc. 1.0%; China East Education Holdings, Ltd. 0.7%; The Fund held no positions in ASM Pacific Technology Ltd.; China Jushi Co.; China Petroleum & Chemical Corp.; Inner Mongolia Yili Industrial Group Co., Ltd.; 51Job Inc., Kingboard Holdings Ltd., iQiyi, Inc., Tencent Music Entertainment Group; or YY Inc. Current and future portfolio holdings are subject to change and risk.