Period ended September 30, 2015
For the quarter ending September 30, 2015, the Matthews Japan Fund (Trades, Portfolio) returned -10.52% (Investor Class), while its benchmark, the MSCI Japan Index, returned -11.70%.
Market Environment:
Japan’s equity markets corrected sharply during the third quarter of 2015, bogged down by weakness in global markets amid fears of China’s slowing growth. A decline in emerging market currencies, the devaluation of the renminbi and the collapse of China’s A-share market weighed heavily on investor sentiment. Overseas investors have responded by taking profit in Japan, and turning net sellers for the quarter.
Japan’s domestic economy remains stagnant with negative real GDP growth for the second quarter of 2015. Despite rising wages and falling energy costs, consumption remains weak as households cope with rising prices of many daily products. Changing the deflationary mindset of Japanese consumers remains a challenge. However, corporate earnings remain robust supported by an improved pricing environment, weak currency and lower fuel prices.
Performance Contributors and Detractors:
During the quarter, the consumer discretionary sector benefited the Fund’s relative performance the most. Retailers such as high-end apparel brand United Arrows and Ryohin Keikaku, the owner of the MUJI brand, performed well on the back of growing sales driven by higher product pricing. We are seeing a polarization in performance amongst retailers with branded businesses that command pricing power against those that lack such attributes.
On the other hand, the industrials sector posed the biggest drag on the Fund’s relative performance. Export orders for capital goods have slowed in recent months as Chinese auto and smartphone manufacturers curtail capital spending amid slow demand. We believe there will be continued demand for automation in Asia but demand will fluctuate with capital expenditure cycles. Mabuchi Motor (TSE:6592, Financial), a producer of small motors for automobiles, and Harmonic Drive Systems (TSE:6324, Financial), a manufacturer of precision speed reduction gears, have both seen valuation multiples contract despite minimal impact on short-term earnings.
Notable Portfolio Changes:
During the quarter, we initiated a position in Dexerials (TSE:4980, Financial), a manufacturer of high-margin niche electronic materials used in display applications. Formerly known as Sony Chemical, the company has thrived since it was spun off a few years ago. We also added TechnoPro Holdings (TSE:6028, Financial), a company that specializes in the staffing of professionals such as mechanical, electrical and software engineers. Labor supply is tight in Japan and we expect the pricing environment to remain favorable for staffing companies with specialized offerings. Both of these companies operate highly cash-generative businesses and are committed to paying out a large portion of their profits to shareholders.
Outlook:
The global economic growth outlook has become increasingly challenging, particularly in emerging markets where currency weakness undermines consumption and corporate profitability. Though Japan is supported by the very accommodative monetary policies of the Bank of Japan, it is not immune to slower global growth. With earnings estimate revisions turning negative, rising uncertainty may lead to a further contraction in valuation multiples. Challenging times will be a test of Japan Inc.’s resolve to improve corporate governance practices and capital allocation policies. Although this may sound quite dire, we still believe there to be a wealth of long-term opportunities for select Japanese companies as they further integrate into the Asian region. Our active investment approach seeks to identify quality businesses that can capture such growth opportunities going forward.
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 Japan Fund (Trades, Portfolio) in the following percentages: United Arrows, Ltd. 1.8%, Ryohin Keikaku Co., Ltd. 2.2%, Mabuchi Motor Co., Ltd. 1.8%, Harmonic Drive Systems, Inc. 1.5%, Dexerials Corp. 1.1% and TechnoPro Holdings, Inc. 1.9%. Current and future portfolio holdings are subject to risk.
