Investment Manager Report
Dear Valued Investors,
2017 was a strong year for Asia’s markets. Japan continued to reflate and China joined it. This allowed corporate profit growth to accelerate. The rest of the region also saw improved performance, but policymakers in India and throughout most of Southeast Asia did not move to significantly stimulate their economies. As a consequence, currencies across the region were strong, and it was their strength that helped fixed income returns and bolstered confidence among foreign investors to the region. However, I would’ve thought a bit more stimulus was warranted in several economies. Had they received such stimulus, currencies might not have been quite as strong, but equity returns might well have been even better.
For the benchmarks, most of the performance was concentrated in relatively few names, which made the benchmarks tough to beat. This is largely a portfolio construction issue. Although some of the best-performing names were indeed good companies and companies that we held in our portfolios, it is not always wise to hold such concentrated positions from a risk standpoint. In single country portfolios, there may be greater justification for large positions in individual names, but it is a bit harder to justify doing so in core regional portfolios that aim to diversify across country and sector. For the dividend-focused portfolios, the issue was complicated further by the fact that many of these companies did not pay a dividend, or they had yields that were severely compressed by expensive valuations. These strong-performing names were largely in the technology sector and thus the relative performance of portfolios was impacted this year by technology weightings relative to benchmarks.
Even where portfolio managers were unable or felt it unwise to build outsize positions in some of these mega-cap growth companies, however, they were able to find good ideas elsewhere. Many of our portfolios benefited from stock picking in mid- and small-cap companies and particularly among China’s domestically listed A-shares, where years of research is now paying off for clients, as access to these companies has improved dramatically over the course of the past 24 months.
In 2017, we also saw some signs of excess. The bitcoin phenomenon has been an exhilarating one to watch, even as the idea of intrinsic value remains elusive for cryptocurrencies and underappreciated by their backers. Hong Kong’s IPO market ran hot too as retail participation soared. This speculation, coupled with the extreme concentration of returns in a few stocks, led some to fear that markets are vulnerable to a setback. Whilst this may be true in the limited sense of the benchmarks, I am less concerned about broad markets and economies. In a broad sense, economic growth seems strong globally and monetary policy is relatively benign. The big risks seem to be the possibility of overtightening by the Fed or understimulation by ASEAN (Association of Southeast Asian Nations). However, risks of a big monetary mistake by policymakers appear slight at the moment. If this is so, then growth can continue to be strong and hopefully market performance can continue to broaden across sectors, countries and down the market-cap spectrum. It may be a year in which markets do better than benchmarks.
In such an improved atmosphere for economic growth, as growth becomes less scarce, I would expect mid- and small-cap companies to do better and growth-at-a-reasonable-price stocks to outperform pure growth strategies. It will be interesting to see if investor sentiment changes too—whilst global clients have generally become less bearish on Asia, few are overweight the region. Much of the allocations we have seen this year appear to be tactical in nature and focused on large exchange-traded funds. It could be that next year might see more enthusiasm for active strategies.
A Word on Valuations
Whereas average valuations in the region might appear neither obviously cheap nor extremely expensive, this average does obscure a significant divergence in valuations between fast-growing and slower-growing companies. Whilst such a divergence always exists, in my opinion it is currently quite large. This doesn’t necessarily have implications for the performance of the broader market but it does mean that long-term investors have to be cautious when they think about growth. As all businesses can face disruptions and competition, it is risky to “straight-line” current growth into the far future. If it appears that market valuations imply such expectations, it may be wise to explore better value in stocks that perhaps have not been so much the focus of attention recently.
For me personally, I remain optimistic about economies and markets. However, I am one of life’s worriers and I am disturbed by the speculative activity in some stocks, IPOs and yes, the cryptocurrencies. It can be hard as fundamental investors to watch these trends unfold and accelerate, even while trying to remain calm. But that is why we have a committed team of portfolio managers seeking to filter out fundamental nuggets from the silt of rumour and noise. It’s our job to keep our heads clear and focused on long-term, bottom-up investing in Asia’s businesses and domestic growth. If we can do that and avoid the excess, I am hopeful that we will do a good job and manage the risks.
As always, it is a privilege to be your investment advisor. Here’s to a great 2018 in everything you do!
Robert Horrocks, PhD
Chief Investment Officer
The views and information discussed herein are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve addition¬al risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results. 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. Matthews International Capital Management, LLC (“Matthews Asia”) and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.