For the first half of 2021, the Matthews China Fund (Trades, Portfolio) returned 7.00% (Investor Class) and 7.13% (Institutional Class), while its benchmark, the MSCI China Index, returned 1.89% over the same period. For the quarter ending June 30, 2021, the Matthews China Fund (Trades, Portfolio) returned 4.33% (Investor Class) and 4.38% (Institutional Class), while the benchmark returned 2.32%.
Market Environment:
China equity markets recovered in the second quarter post a volatile first quarter, driven by resilient first quarter results coming out of the A-shares. Investors used the opportunity of the correction seen in the first quarter of 2021 to buy back into areas of secular growth including that of health care, consumer discretionary and information technology sectors. On the other hand, real estate in China saw weakness on continued policy tightness. The financials sector also saw a pullback over the second quarter as investors continued their focus on growth opportunities in China.
China’s macro environment remained relatively stable and the central bank's monetary policy remained largely unchanged. Consumption industries in China largely remain on a recovery track although consumption patterns have not entirely recovered to pre-COVID levels. Industrial industries continue to face worries of raw material cost inflation but we note that this is a manageable risk. A slower pace of increase is expected in the second half of the year and a still strong consumer demand will facilitate the ability of companies to pass on costs through higher prices in our view. Valuations in China remain attractive at mid-teens price-to-earnings multiple coupled with low teens earning per share (EPS) growth given that the quality of earnings growth continues to become more secular and higher quality in nature.
Contributors and Detractors:
Strong stock selection drove the Fund’s outperformance in the first half. From a sector perspective, stock selection in financials and information technology contributed to relative performance. Among the portfolio’s financials holdings, our holding in China’s premiere banking franchise, China Merchants Bank Co. (SHSE:600036, Financial), did well given attractive valuations and the bank’s ability to continue to provide financial solutions to high net worth individuals. Elsewhere in financials, our holdings in brokerages also did well. Our overweight in brokerages stems from cheap valuations and still strong fundamentals and earnings growth given the brokerages’ ability to expand service offerings as China’s capital markets deepen.
On the other hand, stock selection in the consumer discretionary and real estate sectors detracted from relative performance. The portfolio’s holding Midea Group Co. (SZSE:000333, Financial), a domestic demand-oriented consumer discretionary company, , suffered from weaker performance given concerns about rising raw material prices compressing margins. However, we believe that consumer demand still remains resilient in China, which will likely facilitate the ability to pass on prices in the near future. In real estate, a continued tighter policy environment resulted in the weak performance of Times China Holdings (HKSE:01233, Financial), a southern China focused developer. We believe that this presents the opportunity for market consolidation over the longer term, and that leading regional players such as Times China should be able to grow market share under these conditions given their strong balance sheets. Real estate opportunities in China are also attractively valued and may offer high dividend yields making the risk reward still favorable in our view.
Portfolio Changes:
Chinese growth stocks recovered in the second quarter after a healthy correction in the first quarter of 2021. During the second quarter, we continued to take the opportunity to reallocate capital into areas of reasonable valuations and high-quality growth opportunities. We consolidated our smaller positions and added positions in financials, information technology, materials and industrials. Taking an all-shares approach to investing in Chinese equities, we continue to find interesting opportunities in the Hong Kong (H-shares) market in terms of both valuation and quality. We continue to find opportunities in domestic A-shares and added some holdings over the quarter which increased the Strategy’s overall exposures in A-shares.
Outlook:
First quarter earnings in China point to a continued recovery in China’s economy. Encouragingly, China’s economy continues to benefit from growth coming from a broad range of different sectors and industries. As a result, cheaper parts of the market have also seen performance recovery given continued earnings delivery. Looking ahead to the rest of the year, we continue to expect corporate earnings to remain on track. While market concerns of increased regulatory scrutiny may persist over the near term, we remain focused on the longer-term fundamentals of the domestic growth engine. Among the most attractive themes from a secular growth perspective include technology upgrades, health and wellness trends, and services that enhance quality of life and premium consumer goods.
As of 6/30/21, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: China Merchants Bank Co., Ltd. A Shares, 4.1%; Midea Group Co., Ltd. A Shares, 1.5; and Times China Holdings, Ltd., 1.2%; Current and future holdings are subject to change and risk.
Earnings growth is not representative of the fund’s future performance.
All performance quoted is past performance and is no guarantee of future results. Investment return and principal value will fluctuate with changing market conditions so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the return figures quoted. Returns would have been lower if certain of the Fund's fees and expenses had not been waived. Please see the Fund's most recent month-end performance.
Investments in Asian securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid and more volatile than securities markets in more developed markets. In addition, investments in a single-country fund, which is considered a non-diversified fund, may be subject to a higher degree of market risk than diversified funds because of concentration in a specific country.
