Period ended September 30, 2019
For the quarter ending Sept. 30, 2019, the Matthews India Fund returned -5.13% (Investor Class), while its benchmark, the S&P Bombay Stock Exchange 100 Index, returned -4.71%.
Indian equities fell in the third quarter, with much of the decline occurring 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.
Macro-environment challenges included weak demand for car sales and high-end residential real estate, worries about India's fiscal account due to muted tax collections and concerns around the stability of financial markets. The weak capital position of public-sector banks, combined with concerns about credit quality in the shadow-banking system, negatively impacted access to corporate and retail credit. This in turn led to reduced sales of consumer durables, including autos.
Weak demand resulted in a muted inflation number, creating space for the Reserve Bank of India (RBI) to continue its easy monetary policy even though the transmission of rates was not as robust as anticipated. Monsoon rains started late with scanty rainfall, but more than made up for the deficit in August and September. Rainfall in September was the highest on record in 125 years.
Business sentiment was fairly weak leading up to September and began to deteriorate. The central government, sensing weak corporate sentiment, acted promptly by steeply cutting corporate tax rates. The tax rate on new manufacturing businesses was brought down to 15%. These measures have improved confidence on the margins.
Performance Contributors and Detractors:
The Fund underperformed its benchmark during the quarter. From a sector perspective, stock selection within the information technology and communications services sectors detracted from performance. Among individual stocks, business-process outsourcing firm eClerx Services was a detractor. The company's business services include helping companies streamline and outsource repetitive tasks. Growing use of artificial intelligence, robotics and automation have negatively impacted demand for the firm's services. We continue to monitor the position.
Turning to contributors, stock selection in the financials sector was positive in the quarter. Our emphasis on investing in financials with a strong focus on credit quality and liquidity contributed to the Fund's performance. Cholamandalam Investment and Finance, a large non-banking financial services company with 500 branches across India offering auto and home-equity loans, generated positive absolute returns in the quarter even as India's broader equity market declined. With a strong management team in place, the company employs a careful process of vetting borrowers and maintains a liquid balance sheet.
Notable Portfolio Changes:
During the quarter, we exited a handful of positions including Ajanta Pharma and Eris Lifesciences. In the pharmaceutical sector, we see a trend toward greater innovation and decided to exit Ajanta Pharma and Eris Lifesciences to pursue more compelling opportunities. We also exited automotive company Ashok Leyland because of changes in its management structure.
Amid the backdrop of weak demand and favorable oil prices, we expect inflation to remain in check, opening up more room for monetary-policy easing. We expect the RBI together with the finance ministry will put measures in place that would push more transmission of rate cuts into the hands of the end consumer and consequently help improve consumption-led demand. Auto volumes are likely to improve on rising affordability and incentive schemes being promoted by most original equipment manufacturers.
Corporate tax cuts were a long-term measure that may help to improve fixed capital formation in the economy and consequently help create jobs. Attractive rates for new manufacturing set-ups is likely going to incentivize U.S. and Chinese firms that are looking for alternative supply sources to diversify their manufacturing base.
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. Initiatives such as privatization of public- sector enterprises and the opening up of India's financial markets may help grow the economy over the long term. This in turn may increase government tax revenues and improve the fiscal math.
Amid declining investor sentiment, valuations in India are looking more reasonable than in the past three to four years. We currently find many reasonably priced opportunities among small companies, which we believe may offer attractive long-term growth opportunities. As always, we take a long-term approach, stay diversified and seek to invest in companies with the potential to generate attractive returns across a full market cycle.
As of 09/30/2019, the securities mentioned comprised the Matthews India Fund in the following percentages: eClerx Services, Ltd., 0.2%; Cholamandalam Investment and Finance Co., Ltd., 4.9%; The Fund held no positions in Ajanta Pharma, Ltd.; Eris Lifesciences, Ltd.; or Ashok Leyland, Ltd. Current and future portfolio holdings are subject to change and risk.
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The views and opinions in this commentary were as of the report date, subject to change and may not reflect current views. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Fund's future investment intent. It should not be assumed that any investment will be profitable or will equal the performance of any securities or any sectors mentioned herein. The information does not constitute a recommendation to buy or sell any securities mentioned.
The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Neither the funds nor the Investment Advisor accept any liability for losses either direct or consequential caused by the use of this information.