Period ended June 30, 2020
For the first half of 2020, the Matthews India Fund returned -19.37% (Investor Class) while its benchmark, the S&P Bombay Stock Exchange 100 Index, returned -19.29%. For the quarter ending June 30, the Fund returned 19.40% (Investor Class), while its benchmark returned 19.99%.
Amid fears over of the economic impacts of COVID-19 pandemic, Indian equities were highly volatile in the first half of 2020. India's COVID-19 cases increased exponentially in March, albeit from low reported levels. Investors worried that India reacted late in containing the virus and that the country's health care infrastructure may not be adequate. To slow the spread of the virus, the government implemented a nationwide lockdown at the end of March, which lasted through early June. The most notable market declines occurred in March, with India's broader markets down approximately 25% in a single month.
Equity prices then began a rebound from April through June as the lockdown measures started to get relaxed from April onwards. Although Indian shares were some of the strongest regional performers in the second quarter of 2020, their gains were not enough to make up first quarter losses. The government has announced large headline stimulus of approximately 10% of GDP. Loan guarantees and liquidity injections made up the majority of the stimulus, as opposed to direct fiscal spending, which could limit short-term effectiveness.
In terms of economic activity, we are witnessing normalization of economic activity based on high frequency data like power consumption, fuel consumption, highway toll collection etc. While the pace of improvement in May and early part of June was very quick, we have seen plateauing of the same in second half of June.
Performance Contributors and Detractors:
Fund performance was roughly in line with its benchmark for the first half. Contributors to performance included an overweight and stock selection in the health care sector. Among individual securities, Alembic Pharmaceuticals Limited, an Indian multinational pharmaceutical company headquartered in Vadodara city of Gujarat, was a contributor. Alembic Pharma has been expanding its export business on back of more generic product launches in United States. Further, company has also benefitted from substantial market share gains in specific molecules targeting cardio-vascular ailments.
Detractors from performance included a slight overweight and stock selection in the financials sectors. As a cyclical sector, financial stocks were pummeled in the first quarter of 2020 during the market panic phase of the global pandemic. At the same time, financials play an important role in India's equity markets, making up roughly one third of the Fund's benchmark universe. Among individual securities, Shriram City Union Finance (SCUF) Limited was a detractor. A non-banking financial company (NBFC), SCUF is among the largest lenders making small business loans. NBFCs were hit hard in the first half amid liquidity fears, as asset manager Franklin Templeton abruptly liquidated six of its Indian debt funds in April. We continue to monitor our position in SCUF. SCUF is very well capitalized with equity capital in excess of 20%. Over the long term, we believe lending to small businesses has a long runway for additional growth in India, so we remain constructive on the company's future prospects.
Notable Portfolio Changes:
We took advantage of market volatility to add several new positions in the second quarter of 2020. Tata Consultancy Services is an Indian multinational information technology (IT) services and consulting company with headquarters in Mumbai. The pandemic continues to accelerate the need for better enterprise IT solutions, creating growing demand for products that can help companies enhance employee productivity. We also initiated a position in HDFC Life Insurance. HDFC's distribution network spans 401 outlets catering to approx. 2,400 towns and cities across India. It also has offices in London, Singapore and Dubai to services associates in the Middle East. Meanwhile, we exited Cholamandalam Investment and Finance Co., Ltd. (CIFC), a non-banking financial company. CIFC has substantial exposure to commercial vehicle financing segment. It is expected that credit quality in this asset class is going to deteriorate substantially given the inability of asset owners to put their asset to productive use under COVID-19 related lockdown imposed by central government. Given the risk associated, we decided to exit the investment.
We expect economic recovery from COVID-19-induced stress to be gradual. Urban India is going to take longer to recover given that social distancing requirements in dense cities is affecting the pace of economic recovery. However, rural parts of the country has spurred a surprise. After a robust monsoon last year, we are again seeing good rainfall, which bodes well for rural demand and consumption. We are already witnessing strong growth in demand for tractors, two wheelers and crop inputs. Expectation is that demand is going to remain strong through the course of year barring unforeseen circumstances.
While we do not anticipate further fiscal spending announcements, we continue to believe that India's central bank would remain accommodative on the monetary policy side despite the more recent elevated inflation print. However, the uncertain economic outlook is going to keep the financial sector risk averse and that is likely going to affect any near-term monetary policy transmission. Highly rated corporates with stable cash flows will likely see substantial benefit accrue to them on back of cheap financing.
There has been a lot written about inadequate fiscal spending by the central government. In our view, there may be a positive aspect to fiscal restraint, which is likely to create price and foreign exchange stability for India. In the long run, we believe this will help attract foreign capital, as investors would have greater confidence in underlying fiscal stability of the country. Additionally, the government's concerted efforts more recently to further improve the ease of doing business in India, along with tax and financial incentives, will likely create the necessary backdrop for global corporations to consider India as an investment destination.
On the equity markets front, valuations on the surface might look stretched. However, when compared with the anticipated reduction in cost of capital, valuations start to look a lot more reasonable. Given existing conditions today, we think markets are neither cheap nor expensive and hence the path forward would be solely determined by pace of earnings growth.
As of 6/30/2020, the securities mentioned comprised the Matthews India Fund in the following percentages: Alembic Pharmaceuticals Limited, 0.9%; Shriram City Union Finance, Ltd., 2.1%; Tata Consultancy Services, Ltd., 2.4%; HDFC Life Insurance Co., Ltd., 0.8%. The Fund held no positions in Cholamandalam Investment and Finance Co., Ltd. Current and future portfolio holdings are subject to change and risk.