Period ended March 31, 2019
For the quarter ending March 31, 2019, the Matthews Korea Fund returned 1.31% (Investor Class), while its benchmark, the Korea Composite Stock Price Index (KOSPI), returned 2.81%.
South Korean equities were positive in the quarter but lagged broader emerging markets as fears of a slowdown in global growth, especially in terms of global trade, weighed on sentiment. Generally softer export results in South Korea also worried some investors. The Korean won fell toward the lower end of its 12-month range as sentiment toward the currency declined on weaker exports.
Performance Contributors and Detractors:
The Fund's underperformance relative to its benchmark was due to its long-term, structural underweight in the information technology (IT) sector. IT stocks were down sharply in the fourth quarter of 2018, helping our relative performance toward the end of last year. IT stocks rebounded in the first quarter of 2019, dampening our relative performance more recently. Samsung Electronics makes up roughly a quarter of the portfolio's benchmark, the KOSPI. We feel an allocation of that size would present a significant concentration risk to investors, so we tend to maintain a meaningful but smaller position in the security relative to the benchmark.
Meanwhile, a contributor to performance was LG Household & Heath Care, a South Korean cosmetics and skin care company. More than half of the company's customers are Chinese tourists who buy LG Household & Health Care's products at duty free stores in the region. The company has a strong brand story, connecting its products to royal traditions in Korea.
Notable Portfolio Changes:
During the quarter, we initiated a position in KT&G, the largest tobacco company in South Korea. In addition to selling tobacco products, the company is diversifying into areas such as ginseng health care supplements and cosmetics. We initiated a position in KT&G due to its attractive valuation and its potential to raise dividends over the long term. We believe earnings for KT&G's tobacco business could turn around while its current share price does not seem to capture values in subsidiaries such as its ginseng business.
We also rebalanced our holdings between mass-market cosmetics company Amorepacific Group and its higher-end cosmetics sister company, Amorepacific Corp., during the quarter. We decided to exit Amorepacific Group and reinvest the proceeds into our existing position in Amorepacific Corp., believing that Amorepacific Corp.'s higher-end brands may have a deeper competitive moat.
While South Korea's overall economic picture remains mixed, some green shoots are starting to grow. Chinese tourism to South Korea has gradually been picking up again as tensions between China and South Korea over U.S. missile tests that began in 2016 have started to recede. Equity valuations in South Korea remain near levels last seen in 2008, during the Global Financial Crisis, providing room for growth. Amid historically low stock prices, the dividend yield of South Korean equities is very attractive, with the potential for higher dividends possible in the near future. What's more, we continue to see signs of improved corporate governance and shareholder return policies, which is welcome news for investors.
Many smaller companies are undergoing a restructuring process, revamping product line-ups and channel strategies. We continue to look for ways to invest in the next generation of innovative businesses in South Korea, particularly in the small- and mid-cap stock range. We seek companies that can grow by catering to the domestic market, as well as those that can expand into global markets. As always, looking for the most compelling investment opportunities from the bottom up remains at the core of our strategy.
As of 3/31/2019, the securities mentioned comprised the Matthews Korea Fund in the following percentages: Samsung Electronics Co., Ltd., Pfd. 8.1%; Samsung Electronics Co., Ltd. 3.8%; LG Household & Health Care, Ltd., Pfd. 5.1%; KT&G Corp. 2.4%; Amorepacific Corp., Pfd. 1.7%. The Fund held no position in Amorepacific Group, Inc. Current and future portfolio holdings are subject to 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.