For the quarter ending June 30, 2017, the Matthews China Fund (Trades, Portfolio) returned 12.28% (Investor Class), outperforming its benchmark, the MSCI China Index, which returned 10.66%.
Market Environment:
China’s second quarter GDP grew 6.7%, down slightly from the 6.9% growth rate from the first quarter of the year, and on track to meet the country’s 6.5% GDP growth target for the year. The market trends we saw in the first quarter appeared to continue, and China’s economic activity has continued to skew toward its newer economy sectors. While producer prices—a metric that tracks manufacturing activity—continued to decrease from the peak seen in first quarter, other areas such as e-commerce, continued to register strong growth of more than 30% over the first five months of 2017. China has also continued efforts to deleverage its economy in the second quarter, and raised its borrowing rates for most of the second quarter. Elsewhere, high property prices in major Chinese cities continue to be of concern despite the restrictive policies already in place. Property prices in lower tier cities, however, remain priced at more reasonable levels. Equity valuations also continue to be reasonable given better-than-expected earnings growth thus far this year.
Performance Contributors and Detractors:
The Fund outperformed its benchmark during the quarter owing to good stock selection. The top three contributors to absolute performance were information technology holdings. Hangzhou Hikvision Digital Technology (SZSE:002415, Financial), a leader in the video surveillance industry, performed strongly during the quarter and was among the top contributors to performance. Investors were impressed by the firm's new product offerings in smart home, industrial robots and auto electronics on top of solid core business growth. We used the rally to trim some of our exposure as the stock became fully valued. Ping An Insurance Group (SHSE:601318, Financial), a financial conglomerate and China’s second-largest life insurer, was also a main contributor to Fund performance. The company is expected to maintain sustainable and quality growth as its efforts to push out long-term protection products and its success in consumer finance business start to bear fruit. While Tencent Holdings and Alibaba Group were also the top contributors to absolute Fund performance, they were relative detractors during the quarter as the two companies combined accounted for about 26% of the Index (versus 17.6% for the Fund).
Conversely, our holdings in the industrials sector performed poorly and were among the major detractors to Fund performance. China Everbright International, an environmental resource management conglomerate, corrected during the quarter as its rapid expansion has put a strain on cash flow.
Notable Portfolio Changes:
During the second quarter, we exited our position in Chongqing Changan Automobile (SZSE:000625, Financial) as we saw intensified competition among domestic auto brands and a lack of new models from its joint venture with Ford Motor (F, Financial). We initiated a position in Beijing Capital International Airport (HKSE:00694, Financial) as we were attracted to its strong cash flow and the fact that it benefits from a new round of bidding for its duty free shop concession rights. We also added some positions to the materials, health care and consumer discretionary sectors. One such company, Beijing Oriental Yuhong Waterproof Technology, is well-known among Chinese property developers for its quality waterproofing products and brand name, and has consistently gained market share. We exited Fuyao Glass and Brilliance China Automotive as both stocks rallied and were no longer attractively priced.
Outlook:
China’s ongoing transition toward service-oriented sectors continues to benefit a sustainably growing economy. We also note further progress on supply reforms and longer term, we anticipate that China’s so-called “One Belt, One Road” development strategy will ultimately increase China’s presence on the global stage. In late June, we were very encouraged by index provider MSCI’s long-awaited decision to include China’s domestic A-share stocks into its Emerging Markets Index after an evaluation period that took several years. This inclusion will initially be comprised of a list of 222 stocks, representing 0.73% of the MSCI Emerging Market Index and is projected to begin in June 2018. While this marks a relatively small and gradual rollout, the initial inclusion could spur about US$8 billion to US$10 billion in fund flows to China’s A-share markets. It also marks a historic first step toward further inclusion in the future. At Matthews Asia, we believe that this is positive news for China’s domestic equity markets and a testament to the country’s progress in opening up its financial markets. In the long run, we believe that China’s representation in global indices will continue to be enhanced and look forward to identifying good companies at reasonable valuations for our portfolios.
As of 6/30/2017, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: Hangzhou Hikvision Digital Technology Co., Ltd. 2.1%, Ping An Insurance Group Co. of China, Ltd. 5.0%; Tencent Holdings, Ltd. 10.9%; Alibaba Group Holding, Ltd. 6.7%; China Everbright International, Ltd. 1.7%; Beijing Capital International Airport Co., Ltd. 0.9% and Beijing Oriental Yuhong Waterproof Technology Co., Ltd. 0.8%. The Fund held no positions in Chongqing Changan Automobile Co., Ltd., Ford Motor Company, Fuyao Glass Industry Group Co., Ltd. and Brilliance China Automotive Holdings, Ltd. Current and future portfolio holdings are subject to risk.
The views and opinions in this commentary were as of the report date, subject to change and may not reflect current views. 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. It should not be assumed that any investment will be profitable 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.
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.
