For the quarter ending September 30, 2014, the Matthews Japan Fund (Trades, Portfolio) returned -1.26%, while its benchmark, the MSCI Japan Index, declined -2.19%.
Market Environment:
Japan’s weakened currency during the third quarter resulted in a dilution of returns on a U.S. dollar-basis. However, Japan’s equity market continued to rally during the quarter on a local currency-basis with the MSCI Japan Index reaching six-year highs. Markets were driven by the prospects of better-than-expected earnings for Japan’s listed companies, prompted by the -7.59% weakening of the yen versus the U.S. dollar.
We have also begun to see more concrete evidence of wage growth in Japan. Most recent figures show that total wages grew at their fastest pace in 17 years while base wages also rose for five straight months. Though the pace of wage growth is still below the rate of inflation, we believe the ongoing tightness in Japan’s labor market may allow wage growth to be sustained over the medium term.
Performance Contributors and Detractors:
The top contributor to Fund performance during the quarter was Murata Manufacturing (TSE:6981), a leading supplier of electronic components. Murata’s business is expanding briskly, driven by demand from smartphone producers for its technologically advanced components, particularly for the company’s ceramic condensers, saw filters and communication modules. The firm has also benefited from the weaker yen, and has regained market share from South Korean competitors.
VT Holdings (TSE:7593), an automobile dealership, was the largest detractor to Fund performance. The firm hit an operational snag with a decline in its profitable maintenance service business stemming primarily from weaker auto sales that followed the 2011 Fukushima earthquake. In Japan, new cars are required to be inspected after three years, however, since 2011 auto sales were so low, the firm’s revenues from inspections this year sagged. We believe this is a temporary issue and have added to our position with a cautious eye on VT’s progress.
Notable Portfolio Changes:
During the quarter, we increased exposure to mid- and large-capitalization manufacturers with meaningful exposure to overseas business. We believe select Japanese companies are starting to take advantage of the weak yen, taking back market share in sectors such as technology and automobiles. Additionally, we selectively added to consumer-related holdings in companies that have successfully tapped into the growth of Asian markets. On the other hand, we’ve reduced our exposure to the domestic financial sector, namely in banks and real estate.
Outlook:
The recent round of currency movements is largely a reflection of a strong U.S. dollar, driven by expectations of tighter monetary policy from the U.S. Federal Reserve rather than the one-dimensional yen weakness seen in 2013. One major difference is that the price of various commodities, such as oil, iron ore and natural rubber, has also fallen sharply in recent months. As a result, the impact on import cost inflation to Japan has, so far, been mitigated. On the other hand, Prime Minister Shinzo Abe is expected to decide whether to again raise the consumption tax to 10% (from 8%) by mid-December. With wage growth still tracking below inflation, a subsequent tax hike may have an undesirable impact on consumption. Given such an environment, we intend to focus our research efforts on capably managed companies with strong pricing power that can navigate these rough waters.
The views and opinions in this commentary were current as of September 30, 2014. 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 9/30/2014, the securities mentioned comprised the Matthews Japan Fund (Trades, Portfolio) in the following percentages: VT Holdings Co., Ltd. 1.3% and Murata Manufacturing Co., Ltd. 1.9%. Current and future portfolio holdings are subject to risk.
Performance and distribution figures discussed in any of the Manager Commentaries reflect that of the Investor Class Shares.
