Period ended December 31, 2019
For the year ending December 31, 2019, the Matthews China Fund returned 34.56% (Investor Class), while its benchmark, the MSCI China Index, returned 23.66%. For the fourth quarter, the Fund returned 16.56% (Investor Class) versus 14.72% for the Index.
Amid bouts of volatility, Chinese equities ultimately generated attractive performance over the course of 2019. Key themes impacting China's equity markets during the year included U.S.–China trade tensions, the health of China's economy, corporate earnings for Chinese companies and Hong Kong protests. Against this backdrop, Chinese equities climbed a wall of worry and posted strong returns for the Fund.
Amid global macroeconomic concerns, China's domestic A-share market (represented by the Shanghai and Shenzhen stock exchanges) performed considerably better during the reporting period than the offshore China Hong Kong stock exchange and U.S.-listed Chinese American depositary receipts (ADRs). Companies listed in the A-share market tend to represent domestic demand and the domestic consumer base, where local sentiment was fairly optimistic. In contrast, companies listed on the Hong Kong exchange and U.S. exchanges tend to have a larger share of foreign investors, whose sentiment was weak during the year on global macroeconomic worries. Accordingly, we often saw more-attractive relative valuations in the Hong Kong and U.S. markets compared with China's onshore markets. Notably, the Fund takes an all-shares approach and has the flexibility to buy securities on the exchanges where valuations appear attractive.
In terms of global macroeconomic headlines, the progress of U.S.–China trade negotiations waxed and waned considerably during the period. During the fourth quarter, trade tensions eased and foreign sentiment improved considerably. While details of a U.S.–China trade deal were sparse at year end, market participants seemed encouraged by the improvement in rhetoric and tone, as well as a possible rollback of tariffs. Amid trade tensions, we noticed an impetus on the ground in China for companies to substitute foreign technology for domestic know-how. Regardless of the outcome of trade tensions, we believe China is on a path toward greater technological independence. New supply-chain formations are creating opportunities for long-term investors in China's equity markets, in our view.
Performance Contributors and Detractors:
The Fund outperformed its benchmark for the full-year 2019, as well as in the fourth quarter. From a sector perspective, consumer staples and health care were contributors to performance. Liquor producer Wuliangye Yibin is an example of positive stock selection in the consumer staples sector for the Fund. As the second-largest liquor company in China, Wuliangye Yibin specializes in manufacturing “baijiu,” a clear liquor made from grain. Demonstrating high return on invested capital, Wuliangye Yibin also enjoyed improving earnings and a solid growth outlook. Sino Biopharmaceutical is an example of positive stock selection in the health care sector. Sino Biopharm is 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 Biopharm executed well in terms of diversifying and enhancing its product mix to include more innovative oncology drugs, which showed considerable growth.
In contrast, the consumer discretionary sector was a detractor. Travel and leisure-related names such as Trip.com, Galaxy and Shangri-La all contributed to underperformance in this sector. Official statistics painted a mixed picture of the health of travel, but largely the travel and leisure industry in China remained lukewarm in 2019 on the back of a year of rising trade tensions, a weaker renminbi and also decreased visitation to Hong Kong. We exited Shangri-La earlier in the year and Trip.com in the fourth quarter. We remain constructive on Galaxy over the long term and will continue to monitor the position.
Notable Portfolio Changes:
In April 2019, the Fund adopted a secondary benchmark, the MSCI China All Shares Index, which includes a larger weight to China's domestically listed stocks. Over the course of the year, we increasingly positioned the Fund as an “all-share” strategy. Accordingly, we considered all exchanges where Chinese shares trade and looked for the most-attractive valuations and long-term growth opportunities.
In the fourth quarter, we initiated a position in Meituan Dianping, China's largest delivery-food service provider. Chinese consumers have embraced food-service delivery and we expect that consumer uptake can continue to expand. China has a large network of local delivery people, helping to keep the costs of delivery low and affordable for consumers. Couriers tend to use motorcycles to make deliveries. The company enjoyed scale in its industry and continued to gain market share.
We also exited Trip.com in the fourth quarter. As the company expanded globally, we felt it may face stronger competition and decided to sell the stock.
The strength of China's domestic markets reflected several key investment themes we are following. Notably, China's economy is primarily driven by consumption, rather than exports, so local investor sentiment is stronger than foreign sentiment. Consumption remains healthy, benefiting many of the consumer-related sectors we tend to favor. In addition, while GDP growth has slowed slightly, China's policymakers continue to take a prudent, surgical approach to managing their fiscal and monetary stimulus. Stimulus in recent years has been modest and strategic. In the absence of sudden shocks to China's economy, we do not expect much major stimulus ahead.
We continue to see value in the Hong Kong market. The Hong Kong market tends to be more impacted by foreign investor sentiment, which was weak through much of 2019. While foreign sentiment improved in the fourth quarter on easing trade tensions, valuations remain lower in Hong Kong than in China's domestic markets. We continue to look for opportunities across all markets, reflecting the Fund's all-share philosophy.
In addition, we continue to follow the theme of income growth in China, particularly in lower tier, less-developed urban centers. While much of the developed world has neglected its less-developed and interior cities, China's policymakers are developing these areas through strategic infrastructure planning, including the expansion of high-speed rail networks, as well as through housing policies that encourage educated workers to live in these areas. From a bottom-up perspective, we seek to find companies with attractive growth potential with the ability to tap into rising middle-class income. When viewed through a lens of active stock selection, we believe China's domestic growth engine creates compelling opportunities for long-term investors.
As of 12/31/2019, the securities mentioned comprised the Matthews China Fund in the following percentages: Wuliangye Yibin Co., Ltd. 1.6%; Sino Biopharmaceutical, Ltd. 2.1%; Galaxy Entertainment Group, Ltd. 1.1%; Meituan Dianping 1.4%. The Fund held no positions in Trip.com Group Ltd.; or Shangri-La Asia, Ltd. Current and future holdings are subject to change and risk.