Period ended September 30, 2015
For the quarter ending September 30, 2015, the Matthews China Fund (Trades, Portfolio) fell -21.51% (Investor Class), while its benchmark, the MSCI China Index, fell -22.67%.
Market Environment:
During the third quarter of 2015, China’s equity market environment turned extremely bearish, and macroeconomic indicators stayed muted at best. There were several catalysts for the fall in markets, and worries about the growth transition in China reappeared. These worries were exacerbated by declining mainland stock markets from very rich valuation levels. The heavy-handed approach used by authorities in attempting to stabilize this fall also caused investor concern. Chinese authorities, to the dismay of global markets, suddenly adjusted the mechanism for the daily setting of exchange rates. This change was not well-communicated and created much confusion, however we ultimately consider the move to be a long-term positive development. On the economic front, the lack of sequential growth momentum in China continues and has primarily been due to ongoing sluggishness in the property markets, and a slowing of the government’s fixed asset investments in infrastructure. Meanwhile, the government refrained from launching large-scale stimulus programs to spur short-term economic growth, instead continuing with its approach to help stimulate only targeted areas.
Performance Contributors and Detractors:
During the quarter, the health care sector was among the biggest contributors to relative Fund performance. Health care companies overall reported strong earnings in the first half, showing continued growth momentum. Among our health care holdings, Sino Biopharmaceutical (HKSE:01177) was one of the top contributors. Focused on new drug research and development, Sino Biopharmaceutical’s efforts appear to be paying off as the company has found solid contribution from new products while its existing products continue to hold pricing despite competitive pressure. Another bright spot for the Fund was Anta Sports, a branded sportswear company that has benefited from an improvement in brand perception through focused advertisement, and has also shown prowess in managing its inventory cycle over the past couple years.
Performance in the industrial space, which is consumer in nature, was among the biggest detractors to Fund performance. Among our industrials holdings, Air China (SHSE:601111, Financial) experienced intense selling pressure during the quarter as adjustments to the currency mechanism led to balance sheet concerns. China Mengniu Dairy (HKSE:02319, Financial) also posed a drag on Fund performance as weakness in consumer names became more prolonged than many investors had expected. However, we continue to hold on to solid names in the industry and our conviction in the long-term potential of the country’s consumer sectors remains unchanged.
Notable Portfolio Changes:
During the quarter, we increased our positions in the life insurance industry, which significantly boosted our financials weighting. Although life insurers are classified within the financials sector, we tend to view such businesses as consumer discretionary holdings in China. Sales of life insurance policies are showing very positive operating trends as companies continue to penetrate China’s untapped regions. We believe Chinese life insurance policy design and the reduction in the interest rate environment in China have boosted the appetite for such sales.
During the quarter, we exited instant noodle producer Tingyi (HKSE:00322, Financial) as we believed the barriers to entry and competition in its core noodle business continued unabated. We also sold Golden Eagle (HKSE:03308, Financial), the department store operator, as over-supply and Internet channels continue to pose margin and sales issues. The quarter saw unusually high turnover as market conditions allowed us to re-evaluate every position and identify opportunities in stocks that were previously too expensive.
Outlook:
Looking forward, we expect the central government to continue to achieve a balance between non-intervention and major stimulus programs. Targeted accommodative policies have been adopted to prevent the economy from further slowing. The government has been making efforts to accelerate the reform process by encouraging and supporting the private sector economy, and increasing the role of market forces. Capital market reform is also high on the agenda. This area of reform should not be under-estimated, and we anticipate seeing further reforms over the next six months. At current valuations, we see the risk-to-reward ratio as extremely attractive despite the skepticism on China’s growth transition away from heavy industry. We believe the determination of the government to achieve this objective is clear.
The views and opinions in this commentary were current as of September 30, 2015. 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 9/30/2015, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: ANTA Sports Products, Ltd. 2.8%, Sino Biopharmaceutical, Ltd. 2.4%, China Mengniu Dairy Co., Ltd. 0.9% and Air China, Ltd. 2.1%. The Fund held no positions in Tingyi (Cayman Islands) Holding Corp. or Golden Eagle Retail Group, Ltd. Current and future portfolio holdings are subject to risk.
