For the quarter ending September 30, 2022, the Matthews China Fund (Trades, Portfolio) returned -25.57% (Investor Class) and -25.58% (Institutional Class), while its benchmark, the MSCI China Index returned -22.44%.
Market Environment:
Chinese equities were extremely weak in the third quarter as a confluence of negative headlines including worries about a spillover of China’s real estate woes into its broader economy, lingering COVID restrictions and geopolitical tensions weighed on its economy. China’s property market sentiment has been hit hard and continued to struggle as potential buyers and local government cast doubts on whether some financially distressed developers can finish and deliver their pre-sold homes on time. COVID-related worries reappeared as cases jumped in the mega city of Chengdu, with a population of over 20 million, spurring a city-wide multi-day lockdown and mass testing—a protocol which has been discouraged since May of this year. In addition, in late July, a group of four companies were added to the SEC’s listed of potential de-listings from U.S. exchanges, and news that U.S. House Speaker Nancy Pelosi may visit Taiwan added to investor nervousness.
The People’s Bank of China (PBOC) announced a series of monetary and fiscal support measures during the quarter, including another cut to its 1-year policy rate and a lowering of its longer-term loan prime.
Performance Contributors and Detractors:
The portfolio’s overweight to A shares detracted from performance in the quarter. The A-share markets experienced a pull back on weak consumer sentiment given the Chinese government’s zero-COVID policy which has impacted the domestic market much more so than the Hong Kong market in our portfolio. From a sector perspective, allocation and stock selection within the real estate sector detracted the most from relative performance. The portfolio’s real estate holdings including CIFI (HKSE:00884, Financial), a property developer focused on building houses near the outer perimeter of tier-one cities, fell amid deepening market concerns about the outlook of the overall property market in China.
On the other hand, stock selection within consumer discretionary and a higher weighting to the industrials sector contributed the most to relative performance. Among the portfolio’s industrial holdings, Shanghai International Airport (SHSE:600009, Financial), one of China’s major airports, was among the top contributors to relative performance. Although international travelers provide more revenue for the airport, it has benefited from pent up demand in domestic travel. And while international outbound tourism may be a few quarters away pending a more pragmatic approach to China’s zero-COVID policy, we expect Shanghai International Airport and duty-free operators to stand to beneficiaries of an eventual reopening of tourism activities.
Notable Portfolio Changes:
During the quarter, we added to existing positions within the consumer discretionary sector, and information technology sector exposure was decreased given the pull back in technology related stock prices on increased concerns global semiconductor cycle weakness. We also rotated capital within the real estate sector and sold KWG Living (HKSE:03913, Financial), a property management services provider and added Country Garden Services (HKSE:06098, Financial) which we believe is a higher-quality property management company with a larger market capitalization. We also added to our position in KE Holdings (HKSE:02423, Financial), a housing transactions platform provider. The real estate segment in China overall has also corrected down quite massively from the valuation standpoint and we believe there is more opportunity to recover from a very weak sentiment. The property sector is a very meaningful part of China’s overall economy, and we are continuing to monitor the health of this market very closely.
Outlook:
China’s second quarter results released in July continued to reflect a weak economy dealing with COVID lockdown issues. At the same time, the overhang from a weak property sector and geopolitical tensions continue to plague China’s equity market performance. While the property market continues to be weak, there are signs that the government is increasingly looking to loosen the very tight conditions, including supporting banks to provide financing to developers, and allowing certain developers to issue renminbi-denominated bonds. The larger unknown is geopolitics, including the how U.S. – China relations will pan out. But there have been signs of pragmatism in Beijing. In August, China resolved a long-running dispute with the U.S. Public Company Accounting Oversight Board (PACOB), and PACOB inspectors are now checking the accounting workbooks for Chinese companies listed in the U.S. As for China’s zero COVID policy, while it is difficult to predict an actual point in time where we might see the end of current strict COVID measures, we are cautiously optimistic that the Chinese government will return to a more pragmatic approach, which strikes a better balance between public health and the economy.
All performance quoted is past performance and is no guarantee of future results. Investment return and principal value will fluctuate 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 figures 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.
