For the quarter ending September 30, 2021, the Matthews China Fund (Trades, Portfolio) returned -13.08% (Investor Class) and -13.03% (Institutional Class), while its primary benchmark, the MSCI China Index, returned -18.13% over the same period.
Market Environment:
Chinese equities experienced a large sell-off following recent regulatory announcements created on technology and for-proft education and were the weakest performing in the region in the third quarter. In addition, recent economic data has pointed to a slowdown of economic growth which has been compounded by worries of a weaker real estate sector, as China Evergrande Group, one of the country s largest real estate developers, has run into financial stress. Fears of systemic financial market contagion and the publicized electricity shortages after the government pressed for restrictions of energy production to reduce carbon output contributed to ongoing headwinds. Real estate, consumer discretionary and communication services sectors were weak during the quarter, while cyclical sectors like energy and materials were among the best performers. Mega caps underperformed while mid- and small-cap equities were the most insulated from downside pressure.
Performance Contributors and Detractors:
The Fund's outperformance during the third quarter was driven by both strong stock selection and sector allocation effects. From a sector perspective, stock selection in fnancials, consumer discretionary and information technology contributed to relative performance. Among the Fund's consumer discretionary holdings, Zhongsheng Group Holdings (HKSE:00881, Financial), a luxury auto dealership, contributed to relative performance, given attractive valuations and the continued growth experienced in China's luxury auto market. In the financials sector, our holdings in brokerages, including CITIC Securities Co. (SHSE:600030, Financial) and China Merchants Securities Co. (SHSE:600999, Financial), did well. The Fund's signifcant allocation to brokerages stems from cheap valuations and still strong fundamentals and earnings growth given their ability to expand service offerings as China's capital markets deepen. The information technology sector continued to contribute positively to performance year to date, buoyed by Wuxi Lead Intelligent Equipment Co. (SZSE:300450, Financial) and Naura Technology Group Co. (SZSE:002371, Financial)- electronic equipment companies in the semiconductor and electric vehicle space which continued to beneft from ongoing capital expenditures within these industries as they execute their capacity expansion plans.
On the other hand, the real estate, energy and utilities sectors detracted from relative performance. The portfolio's real estate holdings KWG Living Group Holdings (HKSE:03913, Financial), a property management services provider, and KE Holdings (BEKE, Financial), a housing transactions platform provider, continued to experience weakness on an ever tightening policy environment deepening market concerns about the outlook of the overall property market in China in the third quarter. However, given the sharp pull back in valuations, we continue to believe real estate opportunities in China are attractively valued and may offer high dividend yields, making the risk reward prospects even more favorable. In both the energy and utility sectors, the Fund underperformed given a lack of sector exposure in these areas of the market which have rallied on the back of higher energy prices and efforts to grow renewable energy contributions within the earnings mix of traditional utility companies. e are still assessing the opportunities, but believe that direct opportunities in renewable energy growth can be captured elsewhere in the portfolio, e.g., in industrials and materials.
Notable Portfolio Changes:
During the third quarter, China equities continued to be volatile as real estate concerns weighed on an already fragile market sentiment. We continued to take the opportunity to reallocate capital into growth areas that have experienced a considerable pull back in valuations. We have reduced the Fund's financials exposure slightly and added positions to sectors such as information technology, materials and consumer discretionary, given still strong secular growth opportunities. One addition during the third quarter was Shanghai Baosight (SHSE:600845, Financial), an IT solutions provider that caters mostly to the IT needs of the steel industry. Its parent and largest customer is China's leading steel company, Baoshan Iron and Steel (SHSE:600019, Financial), which has been leading the industry in digitizing its operations. We see an attractive growth potential for the company, as the steel industry continues to digitize manufacturing processes in its effort to maximize efficiency and optimize operations to facilitate growth within a more emissions- controlled world. We closed out our small position in Luxshare Precision Industry (SZSE:002475, Financial), an electronics manufacturing services ("EMS") vendor that supplies leading smartphone companies around the world. We exited Luxshare due to our more cautious view of a moderate outlook on smartphone growth. Taking an all-shares approach to investing in Chinese equities, we have continued to add to the overall A-share exposure of the portfolio, with the overall A-share exposure increasing from around 30% to 3 % over the past six months.
Outlook:
First half earnings results announced in the third quarter in China showed continued COVID recovery and were generally encouraging across the board, except for a weaker recovery in some parts of consumption, e.g., consumer staples, which we continue to monitor closely. The first half results also shed some light on potential government directives over the next year, which we believe will be positively directed toward China's efforts at increased domestic self-sufficiency across a myriad of supply chains (e.g., technology and health care) and environmental efforts to further promote green energy developments in China. We believe there are many opportunities in China that stand to beneft positively from these developments and expect to see meaningful volume expansions, which should help drive positive earnings growth across these supported industries.
As of September 30, 2021, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages Zhongsheng Group Holdings, Ltd., 1.7% CITIC Securities Co., 3.2% China Merchants Securities Co., 2.2% Wuxi Lead Intelligent Equipment Co., 1.8% Naura Technology Group Co., 0.6% KWG Living Group Holdings Ltd., 0.4% KE Holdings, Inc., 0.9% Shanghai Baosight Software Co., 1.5%. he Fund held no positions in China Evergrande Group, Baoshan Iron and Steel and Luxshare Precision Industry.
Current and future portfolio holdings are subject to change and risk.
Earnings growth is not representative of the Fund s future performance.
All performance quoted is past performance and is no guarantee of future results. Investment return and principal
value will fuctuate with changing market conditions so that shares, when redeemed, may be worth more or less than
their original cost. Current performance may be lower or higher than the return fgures quoted. Returns would have
been lower if certain of the Fund's fees and expenses had not been waived. Please see the Fund's most recent
month-end performance.
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.
