Performance figures discussed in any of the Fund Manager Commentaries reflect that of the Institutional Accumulation Class Shares (USD)
For the quarter ending 30 September 2016, the Matthews Pacific Tiger Fund (Trades, Portfolio) returned 7.27%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned 10.25%.
Market Environment:
The Asian markets recovered remarkably in the third quarter of this year. The stage was somewhat set after a very poor 2015 and first quarter 2016. Policymakers in Asia then provided some support to growth through interest rate cuts and fiscal stimulus. With some delay, these effects led to a relatively stable earnings environment thereby supporting stock prices. Brexit created some initial nervousness, but since then we have seen meaningful capital flows into Asia, perhaps as market participants are better appreciating the rewards and challenges in Asia in a balanced way, versus their largely negative perception in 2015. In the quarter ending September 2016, these flows were largely channeled into passive investments.
Both value and growth stocks performed well during the period, but the significant outperformance of the information technology sector dominated the benchmark index returns.
Performance Contributors and Detractors:
The Matthews Pacific Tiger Fund (Trades, Portfolio) participated in the broader market rally but underperformed the benchmark, largely attributable to our under allocation in the IT sector and other hardware stocks. For quite some time, the underperformance of Chinese stocks has driven Asia equity market performance, but this quarter the index’s bias in favor of information technology stocks overwhelmed all other effects. Information technology stocks are now the biggest sector in the benchmark due to the inclusion of ADRs in May, and the IT sector contributed about 40% of the gains for the index during the quarter.
To further highlight, we were disappointed by the performance in one of our consumer discretionary businesses. Orion (XKRX:001800, Financial), a South Korean snack and confectionary company, is coping with a slowdown in China and also investing to launch new products to gain market share and expand their distribution channel. This negatively impacted Orion’s earnings and, hence, the stock was very volatile this quarter. We view this as only a short-term disruption in its business trajectory and not a long-term impairment.
Small caps underperformed quite meaningfully in the broader rally, by about three percent this quarter, negatively affecting our performance given the Fund’s skew towards small- and mid-cap businesses.
Notable Portfolio Changes:
During the quarter, we allocated more capital to some of our investments in China where management is accomplishing their milestones and the future business outlook is improving. We also exited one of our long-standing positions in a Chinese property company due to potentially significant changes in corporate ownership, hence creating significant uncertainty regarding the company’s future outlook.
Outlook:
Stock markets have been quite volatile over the last 12-18 months, compared to the relatively stable operating trends we have seen in our companies. Macroeconomic factors have played a greater role in driving volatility in Asia’s equity markets recently rather than the gradual improvement in earnings expectations. Although the third quarter rally has seen valuations revert back to long-term historical averages, there are still pricing disparities in the market which we view as an opportunity.
Policy support in most of our markets has decisively shifted toward a pro-growth stance with policy makers utilizing various monetary and fiscal tools to boost growth in their respective economies. We have also seen several key reforms being passed, including supply-side initiatives in China and tax amnesty programs in India and Indonesia. Although these reforms are unlikely to have as immediate of an effect on growth as monetary stimulus, they are undoubtedly positive developments to support long-term, sustainable growth in Asia’s economies. One significant reform worth highlighting is the approval of the Goods and Service Tax (GST) Bill in India via both houses of parliament. The tax has stalled for many years due to political hurdles but was finally approved to the surprise of investors. Although it will take time to implement the tax change, it has the potential to create a meaningful improvement in the business environment domestically.
Sources: Brown Brothers Harriman (Luxembourg) S.C.A., Matthews Asia, FactSet Research Systems, Bloomberg
The views and opinions in this commentary were current as of 30 September 2016. 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.
