Investment Manager Report

July 2012

Dear Fellow Shareholders,

 According to legend, King Midas gained the power to turn everything that he touched into gold. But he soon found himself unable to drink or eat as anything that touched his lips aurified instantly. His final tragedy came when, heedless of his despairing protests, his daughter embraced him and thus was transformed into a priceless, lifeless golden statue. Midas had managed to deprive his life of all value.

I see parallels in the current market environment. Cash, cash and cash—it is all that anyone seems to care about. European nations need it to pay down debt as do U.S. homeowners and China’s local governments. This scramble for cash has left machines to idle and rust while labour languishes unemployed. Midas eventually starved for his love of gold—love of cash is starving the world of economic activity.

A “risk on, risk off” narrative has also added a short-term mentality to this love of cash. It has brought valuations in Asia’s markets down to levels that are below historic 20-year averages. At the end of the second quarter, a broad-based universe of Asia-ex Japan stocks trades on about 10X forward 12 month earnings, about a 20% discount to that 20-year average. This is not a fast-moving crisis, and much analysis has been focused on it; consequently, Asia’s low valuations are based on subdued forecasts for the near term.

For us, it does mean that there is more value in the markets than there has been in a while and it is always enticing to see established, seasoned businesses offering good dividend or cash flow yields. At Matthews, portfolio managers witness the high value many investors place on cash—one of the things that we value least. We generally remain fully invested.

It is not that we don’t care about cash—indeed we focus on companies that we believe will be good stewards of capital; that allocate investments carefully, and delight in creating value for shareholders or returning cash to them. As portfolio managers, we are interested in cash only to immediately put it to work. In the past, extreme demand for cash has often been transitory and love of cash seems at odds with Asia’s growth potential.  

We are meeting companies at a faster pace this year than we did last year. This is partly because we are in the enviable position of having been able to increase our investment team’s research resources over the past year and now have “more hands on the wheel.” It is also because during these times, when everyone is focusing on cash, short-term trends and the macro picture, we think it is best to take a view which the market may view as contrarian.

Investment opportunities are quite varied across countries and industries. Although some managers have reported effects of the slowdown in global growth, many of the companies we visit are focused on domestic demand and are somewhat insulated from weaknesses in the West. The portfolios remain biased toward businesses that we believe will grow profitably over the coming decades from the growth in spending of Asia’s households, the development of new products, the enjoyment of new services and the enhanced expression of individual tastes and preferences. As such we hope to avoid King Midas's fate, to focus instead on what can be valued over the long term.

As always, it is a privilege to act as your investment advisor.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC