Matthews China Fund Fourth Quarter Commentary
The Chinese equity market experienced a volatile 2013. China’s economy slowed over the first two quarters of the year mainly due to a weak global economy and less accommodative fiscal and monetary policies. China’s policymakers made impressive efforts during the year to rebalance the country’s economy and shift its emphasis from top-line growth toward more quality growth. Its equity market started to recover during the second half of the year amid signs that the economy had hit bottom, and the economic growth momentum had returned.
The most important economic event of the year stemmed from the central government’s Third Plenum meeting in November. China outlined a blueprint for future growth that involved wide-ranging reform policies. Furthermore, China announced its intention to allow markets to play a more decisive role in allocating resources as well as offer strong government support to the growth of its private sector economy. The Plenum resulted in official plans for many highly anticipated reforms, such as financial sector reform, which could pave the way for further potential liberalization of China’s banking sector. China also formally relaxed its long-held stance on its one-child policy. If executed well, we believe these reform measures should have significant, long-term positive impacts on the economy.
During the year, the Fund’s IT holdings were the biggest contributors to performance. The sector is a key area of focus for the portfolio as we are attracted to firms that can deliver sustainable future growth. The IT industry experienced accelerated growth in 2013, led by Internet-related and e-commerce firms. During a promotional event in November, for example, Alibaba Group, China’s largest e-commerce company, recorded a total of US$5.8 billion in online transactions in a single day. Not only did the private firm break its own one-day sales record, it demonstrated the vast potential in the country’s consumer purchasing power. E-commerce is gaining traction in China and is supported by the country’s spectacular online usage rate. Among the Fund’s top performers for the year were Tencent, a leading online social platform; Sina, an online media provider; and Netease, which provides online game services. We believe that these companies represent some of the best quality names in the Internet-related arena.
Over the past two years, China’s overall consumer-related sectors have been under pressure as the country’s economy has slowed. Increased competition and overcapacity were also seen in certain areas. While the operating environment for consumer companies only marginally improved in 2013, we have seen select companies do well. The Fund maintained overweight positions in consumer discretionary and consumer staples sectors, both of which generally performed well during the year, especially during the fourth quarter. Home Inn & Hotels Management, China’s largest budget hotel operator with a network of over 2,000 hotels, was among the top contributors to Fund performance in the fourth quarter. With solid management and good quality services, the firm has been able to maintain high occupancy levels, offering attractive value to China’s increasing number of tourists and business travelers nationwide.
There were, however, some consumer discretionary holdings that detracted from Fund performance during the year. These included Belle, a leading ladies shoe retailer and Golden Eagle, a domestic department store chain. Both companies suffered from weak consumer sentiment as well as rising competition from e-commerce retailers. Although these companies still face a number of challenges, we believe their leading positions and positive long-term growth potential remain unchanged.
During the year, we consolidated our holdings in the consumer discretionary sector. We exited some holdings that did not meet our expectations, including Li & Fung, a global sourcing and distribution company based in Hong Kong. The company’s historical growth via acquisitions appears to have slowed and its outlook for growth has become tepid. We also sold Parkson Department Store as we believe the company is losing its competitive edge.
Meanwhile, we increased our holdings in the health care, education and industrial automation areas. During the fourth quarter, we added Airtac International Group, a pneumatics equipment and components manufacturer in Taiwan that derives most of its revenue from China. The company is benefiting from the growing demand for automation in China.
Economic indicators for 2014 in China are still mixed. However, since the middle of 2013, they have generally pointed toward a gradual recovery. We will be monitoring the news regarding the Chinese banks’ liquidity. While we share investor concerns over China’s bank liquidity issues and the condition of its banking sector overall, we also believe a collapse of the sector is unlikely. We will also monitor the execution and implementation of the ambitious reform measures announced during the Plenum meeting. We understand that achieving significant structural reforms may likely involve a difficult and bumpy path. However, we are encouraged by China’s stated determination to carry out the reforms, and believe the measures should ultimately improve the overall quality of China’s economy.
The views and opinions in this commentary were current as of December 31, 2013. 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.
Statements of fact are from sources considered reliable, but neither the Funds nor the Investment Advisor makes any representation or guarantee as to their completeness or accuracy.
As of 12/31/2013, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: Tencent Holdings, Ltd., 3.1%, Sina Corp., 2.5%, NetEase, Inc., 1.6%, Home Inns & Hotels Management, Inc., 2.5%, Belle International Holdings, Ltd., 1.4%, Golden Eagle Retail Group, Ltd., 1.3%, and Airtac International Group, 0.7%. The Fund held no positions in Li & Fung, Ltd., or Parkson Retail Group, Ltd. Current and future portfolio holdings are subject to risk.
Performance and distribution figures discussed in any of the Manager Commentaries reflect that of the Investor Class Shares.