For the year ending December 31, 2020, the Matthews China Fund (Trades, Portfolio) returned 43.05% (Investor Class) and 43.23% (Institutional Class), while its benchmark, the MSCI China Index, returned 29.67%. For the fourth quarter, the Fund returned 12.69% (Investor Class) and 12.69% (Institutional Class) versus 11.21% for the Index.
Market Environment:
Chinese equities were stand- out performers among global peers in 2020. Following some early missteps in addressing the pandemic, Chinese authorities shifted gears quickly, acting decisively to limit travel and controlling its borders while working with world health organizations to control the outbreak. In addition, policy actions meant to assist small and medium- size enterprises were implemented including an increase in loan quotas, lowering of borrowing rates, a delay in loan repayments and tax relief. The result was an early 2020 outperformance of Chinese equities. The second quarter of 2020 was lackluster for equity prices, even though anecdotes from our local ofces and ofcial economic data implied that recovery was well under way as factory workers reported back to the assembly line, local shops and restaurants accepted walk-in customers and some travel restrictions were lifted.
Chinese equities posted strong returns in the third quarter but most of those gains were registered in the frst two weeks of the quarter — refecting increased tensions between the U.S. and China. Chinese manufacturing data pointed to a continued V-shaped recovery and a bright spot within the data suggested that small, private businesses were beginning to participate in the rebound. In the fnal quarter of the calendar year, Chinese equity returns were strong again, but lagged other markets in the region. Some growth stocks within the communication services, health care and discretionary sectors took a breather while valued-oriented names within materials, energy and fnancials outperformed. With the coronavirus pandemic held in check across China, cities, governments, businesses and schools remained open for regular, daily activities. Government micro- reforms in areas such as health care, education and housing continue to support sustainable growth in economic activity.
Performance Contributors and Detractors:
Stock selection in information technology, industrials and fnancials contributed to performance for the full year. A contributor among individual stocks was e-commerce company JD.com, which experienced increased demand for its services during the pandemic. As the second largest e-commerce company in China, JD.com (JD, Financial) has a broad reach and its proftability is improving. Logistics-oriented businesses tend to be very capital intensive in their early years, but with much of JD.com's logistic infrastructure already in place, we expect that the business may be less capital intensive going forward. China has many metropolitan densities and the complexity of making deliveries to most households is high, creating a competitive moat for an e-commerce player such as JD.com.
On the other hand, stock selection in health care and materials, as well as an overweight to real estate, detracted from performance for the full year. A detractor among individual stocks was Sinopharm (HKSE:01099, Financial), China's largest pharmaceutical distributor and one of the few distributors with a meaningful nationwide presence. The company saw weak results in the frst half of 2020 owing to negative economic impact from the COVID-19 outbreak. Hospital visitation during the pandemic fell, which reduced pharmaceutical distribution needs. At the same time, the company saw increased operational expenses associated with the prevention and containment of the virus situation. Sinopharm trades at attractive valuations and commands a still large and dominant presence in China's healthcare distribution industry. We continue to monitor this position for updates and operational improvements.
Notable Portfolio Changes:
During the fourth quarter, we initiated new positions in Kingsoft Corp. and Wuxi Lead Intelligent Equipment Co. Kingsoft (HKSE:03888, Financial) is a technology company with three main businesses: online gaming, cloud services and software services. The company's online gaming business provides a stable and growing source of cash fow. Its cloud services business supports companies with growing data and storage needs, including major clients in the social media and entertainment industries. Kingsoft's software services business is growing beyond its traditional presence in enterprise operating systems into consumer facing software services where penetration of paying users is currently very low with room to grow. In our view, Kingsoft trades at a deep discount to the sum of the parts valuations for each of the individual businesses. Wuxi Lead Intelligent Equipment (SZSE:300450, Financial) is a full-service battery equipment provider with strong ties to China's largest battery manufacturer, CATL. We believe that on-going growth in electric vehicle (EV) sales will spur capacity growth for batteries. Such increased CapEx investments drives the need for equipment investments. The company also has an opportunity to expand its customer base from mainly Chinese domestic customers to global clients as well.
Outlook:
Going forward, China seems well positioned for continued stability as monetary aggregates have been balanced for several months while China's rebounding economy and solid mid-teens consensus earnings growth should support current valuations. The newly released fve-year plan could support businesses benefting from the '"dual-circulation" announcement focused on domestic demand and self-sufciency in key areas of technology, innovation, health care and the digitalization of the economy.
Market participants believe a Biden administration could potentially focus less on trade-related issues, in favor of a multi-lateral approach on topics related to market access, climate change and human rights. Investors expect more predictability and less headline risk associated with U.S. – China relations going forward. On the domestic front, the latest Chinese economic data points to continued recovery led by consumption, manufacturing activity and investment. In addition, analysts expect upside earnings momentum to carry through 2021 driven by robust economic activity.
As of 12/31/2020, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: JD.com, Inc. A Shares, 2.9%; JD.com, Inc. ADR, 2.9%; Sinopharm Group Co., Ltd. H Shares, 0.1%; Kingsoft Corp., Ltd., 1.4%; Wuxi Lead Intelligent Equipment Co., Ltd. A Shares, 1.1%. The fund held no position in Contemporary Amperex Technology Co., Limited (CATL). Current and future holdings are subject to change and risk.
The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Neither the funds nor the Investment Advisor accept any liability for losses either direct or consequential caused by the use of this information.
The views and opinions in the commentary were as of the report date, subject to change and may not refect current views. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions refect 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. It should not be assumed that any investment will be proftable or will equal the performance of any securities or any sectors mentioned herein. The information does not constitute a recommendation to buy or sell any securities mentioned.
