Period ended March 31, 2020
For the quarter ending March 31, 2020, the Matthews India Fund returned -32.48% (Investor Class) while its benchmark, the S&P Bombay Stock Exchange 100 Index returned -32.73%.
India's broader markets fell sharply in the month of March amid fears about the potential impact of coronavirus on India's economy. Notably, the market decline in India preceded any actual health care crisis. Market participants feared that India's dense cities and sparse health care infrastructure might be particularly vulnerable to the epidemic. While these concerns are genuine, they had not come to fruition in the reporting period.
On a positive note, India's government instituted nationwide shelter-in-place orders on March 25 to reduce the speed of transmission in the country. In addition, India's Finance Minister announced a fiscal package of 1.75 trillion India rupee (0.8% of GDP) in hopes to aid low-income households while in lockdown. Many market participants expect further fiscal support in coming weeks. India's central bank announced rate cuts of 75 basis points (0.75%) and importantly, the liberalization of certain securities within government bond markets, which could open the door for more foreign participation and even eventual index inclusion.
India's small- and mid-cap stocks underperformed large-cap stocks. More cyclical sectors and leveraged businesses like energy and financials underperformed less cyclical businesses like communication services and consumer staples. Most analysts are revising downward their year over year GDP growth projections—some by more than 50%. Similarly, earnings expectations are expected to be cut. We believe Indian markets have already priced in significant reductions in earnings.
Performance Contributors and Detractors:
periods of uncertainty, investors tend to rush into the largest and most liquid
businesses, hurting the stock prices of small businesses. The Fund's allocation
to small- and mid-cap stock was a detractor from performance across sectors,
mostly notably in consumer staples and information technology. Within
financials, our higher exposure to small finance banks and non-bank financials
also was a detractor from performance. In contrast, stock selection within the
industrials sector was a positive contributor, largely led by some of our
exposure to rural India. Much of rural India is insulated from current
shelter-in-place orders and we expect rural parts of the country to return to
normal business sooner. Our high allocation to health care also helped us
deliver a marginally better performance compared to the benchmark index.
Notable Portfolio Changes:
We continued to increase liquidity in the portfolio in the quarter by selling some smaller, less liquid positions. During the quarter, we exited commercial bank Au Small Finance Bank to help improve liquidity. We also exited IT solutions provider NIIT Technologies as part of our valuation discipline. The stock price had appreciated considerably and we chose to lock in profits.
We also added a number of positions, including Reliance Industries, a conglomerate with diversified business lines that include telecom, retail and petrochemicals. We see several potential tailwinds for the company representing opportunities for attractive potential growth. First, the telecom industry in India is going through massive consolidation, a trend that could benefit companies with scale, such as Reliance Industries. Second, the company's brick and mortar retail franchise could greatly enhance its expansion into e-commerce through brand loyalty and recognition. Finally, its refining business has some of the lowest refining costs in the industry and generates attractive cash flows.
Looking ahead, much uncertainty remains in terms of the potential impact of the coronavirus on the India's economy. The current situation of experiencing an instant nationwide economic shutdown is unprecedented in scope. Accordingly, we will continue to watch how the situation evolves. However, stock prices already reflect a good deal of uncertainty. The dramatic decline in stock prices in the first quarter may have been overly pessimistic in our view.
Risks to India's economy include potential strain on its health care system, loss of income among daily wage earners and significant impairment of microbusinesses. On the positive side, we expect further stimulus from the government. The central bank could extend monetary easing, reducing the cost of capital and stabilizing demand in the near term. We also expect the rural side of the economy to continue to improve. Wheat is the main crop of the rabi harvest—agricultural crops sown in winter and harvested in the spring in India—and yields look better than expected.
Our portfolio's emphasis on companies with strong balance sheets means our holdings appear well positioned to weather the uncertainty. We expect companies that can hold steady during the economic shock to come out stronger and more profitable. In the meantime, we see Indian equities as having strong growth potential from a bottom up perspective. As valuations have corrected significantly, businesses are trading far below their fair value. The investable pool of stocks has become much larger, creating an opportune environment for active managers with a long-term view.
As of 03/31/20, the securities mentioned comprised the Matthews India Fund in the following percentages: Reliance Industries, Ltd., 4.5%. The Fund held no positions in Au Small Finance Bank Ltd. or NIIT Technologies Ltd. Current and future portfolio holdings are subject to risk.