For the first half of 2015, the Matthews Pacific Tiger Fund (Trades, Portfolio) gained 8.13% (Investor Class) while its benchmark, the MSCI All Country Asia ex Japan Index, returned 5.59%. For the quarter ending June, the Fund returned 0.56% (Investor Class), while its benchmark returned 0.65%.
Market Environment:
The macroeconomic environment in Asia was challenging over the first half of 2015, with limited evidence of a pickup in demand across the region. Investment demand was sluggish for a variety of country-specific reasons. In China, the government has deliberately steered away from traditional investment-led growth and attempted to gradually move toward consumption. In Indonesia, India and Thailand, government-led investment expectations have fallen short of market expectations, and private investment is missing due to lack of progress over structural reforms. However, there are some hopeful signs emerging. In India, monthly indicators are turning positive. But these can vacillate and need to be sustainable. In China, the real estate sector is stabilizing on the back of lower rates and other supportive measures by authorities.
Asia’s consumption demand has been more resilient on the back of secular increases in wealth. Demand has also been cyclically supported by lower inflation—helped by lower food and oil prices. However, there are some exceptions, including Thailand and Malaysia, where higher levels of debt may pose headwinds to growth in consumption.
Performance Contributors and Detractors:
The tough macroeconomic environment has resulted in difficult business conditions thus far this year. Most businesses in Asia continue to see weak sales growth, although there are some signs of stabilization in profitability, especially in the non-commodity sectors. In the absence of strong earnings growth, the performance in stocks has largely been a result of changes in valuations. Faith in supportive policies in China led to a sharp spike within the mainland equity markets, driving stock prices in sectors like financials.
The portfolio’s underweight, especially in Chinese banks, was among the detractors to relative performance against the benchmark in the second quarter. Indonesia and Taiwan were also among the leading detractors. In Indonesia, our holdings struggled due to currency weakness and uncertainty around the profitability of Perusahaan Gas Negara (ISX:PGAS), the country’s the largest natural gas transportation and distribution company. In Taiwan, holdings have struggled due to negative earnings revisions due to near-term factors and stretched expectations.
Portfolio performance has also been affected by weakness in some currencies, especially among the Association of Southeast Asian Nations (ASEAN). However, the impact is not as great as it was in 2013 at the start of taper tantrum.
South Korea was a top contributor to Fund performance for the second quarter, with holdings in cosmetics and health care industries doing well. Amorepacific (XKRX:090430) continued to gain traction with Chinese consumers. Green Cross (XKRX:006280), one of our health care holdings which focuses on vaccines and blood derivative products, has done well and was rewarded by the stock market as its management has been investing and building its R&D capabilities.
Notable Portfolio Changes:
During the second quarter, we made our first investment in China’s A-share market. We view the gradual opening of China’s domestic markets as a significant development as it expands the subset of companies available for the strategy, especially in consumer-related and health care sectors. We will remain mindful of the valuations. Hence, our allocation in companies we deem desirable will increase only over time.
We continue to take advantage of volatility in the region to trim positions that have done well and whose valuations that have become too rich. We also added opportunities in China and Hong Kong that we believe are attractive. Overall, valuations in India have eased recently. In addition, some of our Indian holdings have been affected due to near-term, stock-specific factors. We will look to take advantage of these short-term price corrections, especially in situations in which long-term fundamentals remain attractive.
Outlook:
Asia’s markets have been wary of the potential for an increase in U.S. interest rates and many Asian currencies have been depreciating. We continue to believe that Asia’s economies are better-positioned to withstand such situations that leave markets anxious. For instance, compared to the summer of 2013, real interest rates across many parts of Asia have increased, providing some cushion against a U.S. rate hike.
Valuation levels across the region have crept up, although it is fair to say that there is higher disparity in valuations across different parts of Asia. While the domestic Chinese equity market has been on a tear recently, parts of the ASEAN and Indian capital markets are starting to more appropriately reflect the weakening growth outlook. Given our benchmark-agnostic approach, we continue to be guided by our understanding of companies and management teams that we believe are capable of delivering steady, sustainable growth at reasonable valuations.
The views and opinions in this commentary were current as of June 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 06/30/2015, the securities mentioned comprised the Matthews Pacific Tiger Fund (Trades, Portfolio) in the following percentages: Amorepacific Corp. 3.3%, PT Perusahaan Gas Negara Persero 0.9% and Green Cross Corp. 2.5%. Current and future portfolio holdings are subject to risk.
