Matthews Asia Small Companies Fund
Period ended 30 September 2018
For the quarter ending 30 September 2018, the Matthews Asia Small Companies Fund returned -9.00% while its benchmark, the MSCI All Country Asia ex Japan Small Cap Index, returned -4.39%.
The third quarter of 2018 was volatile for most emerging markets, including Asia. Weak currencies among developing Asian nations sparked concerns of contagion in the emerging market asset class. In addition, trade war tensions escalated between the U.S. and China. The Chinese currency also weakened but then stabilized toward the end of the quarter. Market sentiment over China's economy has softened since the beginning of the year. The Chinese government took steps to stabilize its internal markets. It relaxed monetary conditions to facilitate liquidity for small and medium enterprises and cut individual income taxes to stimulate domestic consumption.
India's market experienced liquidity concerns in September following a default crisis involving a sizeable non-banking financial company. This default led to the perception of rising risks and tightened liquidity in India's financial sector. Meanwhile India's deteriorating current account caused the Indian rupee to depreciate to an all-time low versus the U.S. dollar. In light of inflationary pressures, the Reserve Bank of India raised interest rates by 25 basis points (0.25%) in August.
As anticipated, the U.S. Federal Reserve raised interest rates by 25 basis points (0.25%) in late September.
Performance Contributors and Detractors:
During the quarter, contractions in valuation multiples among the portfolio's Chinese holdings posed the biggest drag on the Fund's absolute performance for the quarter due to factors including tariffs, negative surprises from government policies and heightened bearishness toward China's economy. In addition, our overweight allocation to China/Hong Kong exacerbated the negative returns. Company-specific factors also led to weak share price performance. For example, one of our largest holdings, Silergy, a China-based design house for analog integrated circuits, was the largest performance detractor during the quarter. The stock sold off due to short-term market concerns over a margin squeeze in the most recent quarter. We believe supply chain-related issues are short term in nature, however, and Silergy is still well-positioned to benefit from China's local sourcing strategy for semiconductor products.
By sector, consumer discretionary holdings, particularly those related to autos, were among the largest detractors to Fund performance during the quarter due to trade war rhetoric and the threat of tariffs, which weakened auto sales in Asia. Some holdings in the industrial sectors also suffered broadly on the back of the moderating manufacturing activity and capital expenditure spending in China.
Both absolute and relative performance for the Fund were lackluster for the third quarter—a sharp contrast to the first six months of 2018. On the other hand, our caution relating to some parts of the Indian market and our stock selection helped to mitigate some downside in a volatile environment.
Notable Portfolio Changes:
We identified some risks in our financial holdings in India that are typically correlated with a monetary tightening environment as India's central bank began raising interest rates earlier this year. During the third quarter, we reduced our exposure to India's non-banking financial companies by exiting our holdings in companies such as Cholamandalam Investment and Finance, and Shriram City Union Finance. We believe the asset quality and growth visibility of such firms are likely to be compromised in the new interest rate and liquidity environment. We also exited and trimmed some high flyers in the health care and information technology sectors where we deemed valuations had become overly rich. AK Medical, a Chinese medical device maker, and Chilisin Electronics, a Taiwanese passive component maker, both experienced sharp spikes in their share prices since late last year; hence, we decided to exit these positions and lock in profits.
We added to positions and initiated positions in companies with defensive qualities such as data center operator SUNeVision Holdings in Hong Kong as recent earnings indicated that both growth and expansion plans are on track. Chief Telecom in Taiwan, a telecommunication service company, is another example of growth opportunity in the data and network service industry. We also initiated positions in services-oriented and consumer-facing companies in various countries that we believe are well-positioned to capture the changing needs of Asian consumers. We see compelling opportunities in businesses such as payment platforms, online entertainment and private education.
Rising interest rates and global trade war rhetoric might continue to negatively impact sentiment in equity markets over the shorter term. We are cautious about liquidity in areas of the lending environment and prefer to position the portfolio toward companies with minimal reliance on external capital funding. On the positive side, shares of higher quality companies have been sold off along with the market due to general risk aversion. We believe this presents us with opportunities to build positions at attractive valuations.
External factors, such as rising oil prices and a strong U.S. dollar, can cast an overhang for some parts of Asia. There may specifically be concerns over the health of current accounts in countries including India, Indonesia and the Philippines. Hence inflationary pressures within their domestic economies and the strength of their currencies might present challenges for corporate earnings.
On the political front, Thailand, Indonesia and India are poised to hold key elections in 2019, where election outcomes can also create short-term uncertainty. Recent policies set forth by China's leaders in regulating various industries have caused concerns about their potential impact on private companies. We will continue to monitor these developments. We remain convinced that solid structural tailwinds for entrepreneurial activities in Asia are in place. Identifying adaptive and capital-efficient small-cap companies that are well-positioned in secular growth area such as domestic consumption and productivity improvements remain our area of focus as long-term investors.
Performance figures discussed in any of the Fund Manager Commentaries reflect that of the Institutional Accumulation Class Shares and have been calculated in USD, including ongoing charges and excluding subscription fee and redemption fee investors might have to pay. Performance details provided for the Fund are based on a NAV-to-NAV basis, with any dividends reinvested, and are net of management fees and other expenses. Past performance information is not indicative of future performance. Investors may not get back the full amount invested.
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.
Information contained herein is sourced from Matthews Asia unless otherwise stated. The views and opinions in this commentary were as of the report date, subject to change and may not reflect the writer’s 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.
Investors should not invest in the Fund solely based on the information in this material alone. Please refer to the Hong Kong Offering Document for further details of the risk factors.
Sources: Brown Brothers Harriman (Luxembourg) S.C.A, Matthews Asia, FactSet Research Systems, Bloomberg