For the year ending December 31, 2016, the Matthews China Fund (Trades, Portfolio) declined -5.18% (Investor Class), while its benchmark, the MSCI China Index, returned 1.11%. For the fourth quarter of the year, the Fund declined -6.14% (Investor Class) versus -7.07% for the Index.
Market Environment:
Over the course of 2016, China has maintained steady economic growth with modest inflation. China’s producer price index steadily improved from -5.3% at the beginning of the year to 3.3% in November, as supply-side reform in oversupplied sectors, such as coal and steel, have yielded meaningful results. Retail sales remained strong throughout the year, and domestic consumption continued to serve as a major driving force for the country's GDP growth. The government has largely stayed on course with economic restructuring and reform despite some downward economic pressure. Given the strength of the U.S. dollar, the Chinese renminbi depreciated about 7% in the last year. As a result, China suffered capital outflows, as indicated by the third consecutive year of decline in its foreign exchange reserves.
Performance Contributors and Detractors:
The consumer discretionary sector was the major source of relative underperformance throughout 2016. JD.com and Chongqing Changan Automobile were two major detractors. JD.com (JD, Financial) suffered from renewed skepticism in the associated costs involved with its logistics rollout. Chongqing Changan (SZSE:000625, Financial)’s underperformance was harder to explain given it was trading at less than 5x earnings and a dividend yield of over 6%. The company is still struggling to make money in its locally branded cars, but we believe this is already reflected in the price. The real estate sector was also a drag for the year although the physical market was robust. Our two key holdings, China Overseas Land (HKSE:00688, Financial) and Investment and China Resources Land (HKSE:01109, Financial) have suffered from negative macro noise, but we believe as 2016 came to a close, these two companies strengthened their competitive positions in the sector.
Semiconductor Manufacturing International Corporation was a major contributor to the Fund’s performance for the year. Its continued expansion in the semiconductor space and full utilization has enabled it to reach a scale where it can self-fund its capital expenditure requirements.
Notable Portfolio Changes:
In 2016, we continued to streamline the Fund and now have between 35 and 40 holdings. The rationale for this is to ensure that all our holdings in the Fund are high conviction. Reducing the number of positions ensures that only the best stocks survive. We have exited a number of holdings in this consolidation process, including Air China, Bank of China (Hong Kong) and China Vanke. We recently added Sina (SINA, Financial) and Brilliance China Automotive Holdings (HKSE:1114). Sina is an internet company that attempts to capture the social media trends that are evolving in China by providing a diverse platform for communication. Brilliance China, BMW’s joint venture partner in China, has come to the end of its inventory destocking cycle and has several new models planned for 2017.
Outlook:
China's economy has made significant progress in supply-side reform and achieved stable growth throughout 2016. It is also encouraging to see the producer price index has consistently improved since the beginning of the year. However, we remain cognizant that the nation’s structural reforms are an ongoing process. Looking ahead, China’s relatively loose fiscal and monetary policies are unlikely to soon change. We expect that China's fiscal policy and continued adjustments in the services sector will remain major drivers for its economic growth. The government will continue its efforts to stem capital outflows due to the depreciating currency. The new Trump administration may introduce some uncertainty on the trade front between China and the U.S., which we will monitor closely. In managing the portfolio, we will continue to focus on companies that are less affected by macroeconomic uncertainty and that we believe have sustainable earnings growth and dominant market positions.
The views and opinions in this commentary were current as of December 31, 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 12/31/2016, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: JD.com, Inc. 2.1%, Chongqing Changan Automobile Co., Ltd. 1.7%, China Overseas Land & Investment, Ltd.2.3%, China Resources Land, Ltd. 2.3%, Semiconductor Manufacturing International Corp. 2.8%, SINA Corp. 2.5%, Brilliance China Automotive Holdings, Ltd.2.1%. The Fund held no positions in China Vanke Co., Ltd., Air China, Ltd., and Bank of China (Hong Kong), Ltd. Current and future portfolio holdings are subject to risk.
