For the quarter ending September 30, 2016, the Matthews China Fund (Trades, Portfolio) returned 14.95% (Investor Class), outperforming its benchmark, the MSCI China Index, which returned 13.96%.
Market Environment:
China’s market environment improved in the third quarter of the year as the major macroeconomic issues from the start of the year dissipated. Monetary and fiscal stimulus improved the operating environment on the ground and stock fundamentals started to assert themselves. Continued efforts to restructure the economy and an ongoing focus on supply-side reform provided tailwinds for the market. The market appears to have begun acknowledging China’s continuing efforts to achieve a dual mandate of stable growth with bottom-up restructuring. One area that has continued to boom is the property sector in major urban markets with housing priced up, more than 20% year-over-year, for several cities. This renewed enthusiasm is starting to spread across the country into smaller cities and is soaking up much housing inventory that had previously been a concern.
Performance Contributors and Detractors:
Consumer discretionary stocks were among the main contributors to performance. In particular, Vipshop Holdings (VIPS, Financial), a leading online discount retailer, and appliance manufacturer Gree Electric Appliances (SZSE:000651, Financial), have done well. Vipshop continues to diversify its active users in online discount inventory clearances aimed at younger consumers. Although the average value of each purchase is lower, the volume increase generally offsets this, and appears to be leading to a broader business offering. The company is also increasingly selling more seasonal products as well as discounted product as its distribution reach grows. Gree Electric Appliances re-listed after it acquired an alternative energy battery producer. Although the merits of this acquisition remain to be seen, its core air conditioning business is showing signs of strength as the excess inventory in the channel has dissipated.
In recent months, life insurance stocks also provided strong performance as people started to focus on the long-term product improvements offered by insurers rather than focusing on shorter-term investment returns. CITIC Securities (SHSE:600030, Financial), a leading brokerage, was the major absolute detractor as volumes in China’s domestic stock markets remained weak and investors remained unwillingly to look past what we believe is a short-term issue.
Notable Portfolio Changes:
Our most significant portfolio adjustment during the third quarter involved ongoing consolidation of our holdings to approximately 40 stocks. We exited positions in Dongjiang Environment (HKSE:00895, Financial) and consolidated our position in China Everbright International (HKSE:00257) as we believe it to be the industry leader and, it is attractively priced. We also exited Hong Kong Exchanges and Clearing in favor of CITIC Securities (SHSE:60030, Financial) on valuation differentials between the stocks with similar capital market reform drivers. We have added to Alibaba as we believe the company is continuing to show progress in improving its monetization rate in the online shopping channel.
Outlook:
China's economy showed encouraging signs of improvement in the last quarter, particularly as August saw resilient economic data results. China’s efforts to reduce overcapacity in its steel and coal industries yielded meaningful results as prices increased. However, we remain cognizant that the nation’s structural reforms are an ongoing process. We expect that government fiscal policy and continued adjustments in the service sector will continue to serve as major drivers for China's economic growth. Relatively loose monetary policy and expansionary fiscal policy are unlikely to change in the foreseeable future. For the first time in recent years, we also anticipate there will be significant profit growth over the next 12 months, which may provide a tailwind to stock market performance. In managing the portfolio, we will continue to focus on companies that are less affected by macroeconomic uncertainty and that have sustainable earnings growth and dominant market positions.
The views and opinions in this commentary were current as of September 30, 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.
As of 9/30/2016, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: Vipshop Holdings, Ltd. 1.8%, Gree Electric Appliances, Inc. of Zhuhai 2.0%, CITIC Securities Co., Ltd. 3.0%, China Everbright International, Ltd. 2.0% and Alibaba Group Holding, Ltd. 6.9%. The Fund held no positions in Dongjiang Environmental Co., Ltd. or Hong Kong Exchanges and Clearing, Ltd. Current and future portfolio holdings are subject to risk.
