For the quarter ending March 31, 2022, the Matthews China Fund (Trades, Portfolio) returned -20.26% (Investor Class) and -20.26% (Institutional Class), while its benchmark, the MSCI China Index, returned -14.19% over the same period.
Market Environment:
The first quarter of the year was broadly negative and choppy for emerging and Asian equity markets for the third consecutive quarter. Chinese equities were weak led down by the confluence of COVID-19 case spikes resulting policy enforced lockdowns in tier one cities, ADR delisting pricing pressures and investor worries that Russia-like sanctions could be implemented upon select Chinese companies. Although macro data in January and February contained upside surprises, the Chinese government’s zero-COVID policy continued to weigh heavily on certain sectors.
The Chinese government announced during the quarter that they favor a 2022 GDP growth rate of “around 5.5%.” In our opinion, this was an important “stake in the ground” announcement. Because of the significant lockdown pressure on consumption, GDP growth will need to be created elsewhere in the economy in order to reach the 5.5% growth target. We envision a battle between temporary lockdowns and stimulus to unfold. Regardless, we think the government will largely succeed in supporting the Chinese economy and that corporate earnings will remain some of the highest globally in 2022-23.
Performance Contributors and Detractors:
The portfolio’s overweight to A shares detracted from performance in the first quarter. The A-share markets experienced pull back on weak consumer sentiment given the Chinese government’s zero-COVID policy, and a general property market weakness. The A-share market has also performed well over the past two years, and growth sectors, which have become expensive, are undergoing a healthy correction. Around half of the portfolio exposure is currently to A-shares. Despite the recent pull back in the A-share market, we intend to maintain rather similar levels of exposures and believe that there are still many secularly growing opportunities in this market.
From a sector perspective, financials detracted the most from overall relative performance largely due to the portfolio’s overweight in securities companies, including China Merchants Securities Co. (HKSE:06099, Financial) and China International Capital Corp. (HKSE:03908, Financial). Securities companies tend to be sensitive to market and trading sentiment and therefore underperformed during this period of market volatility. Longer term, we still view these companies as attractively priced businesses that would benefit from China’s deepening capital markets.
On the other hand, the portfolio’s underweight to U.S. ADRs was beneficial given continued pressure on this space with rising risks of ADR listings, including the onset of the Russia and Ukraine war which weakened sentiment on emerging markets. From a sector perspective, allocation and stock section in real estate contributed the most to relative performance given our holding in China Overseas Land and Development, which is a state-owned enterprise (SOE) property developer. SOE developers have stronger balance sheets and portfolio managers believe they will benefit from the ability to buy attractively priced assets as the consolidation of the real estate continues.
Notable Portfolio Changes:
The portfolio’s A shares exposure continued to trend up over the quarter to around 50%. Given the selloff in platform companies, we think there is lot of value emerging and added a few names including Pinduoduo (PDD, Financial), one of China’s largest ecommerce shopping platforms with a focus on lower tier city residents. Platform companies in China continue to be dominant businesses and they are still largely unmonetized at the moment. While there will be a moderation of growth, we do not think that regulations derail these businesses from growth entirely. The focus going forward will be on quality growth is a promising sign.
We also increased exposure to the IT sector, driven by more A-share companies, including semiconductor equipment company Beijing Huafeng Test & Control Technology (SHSE:688200, Financial) and semiconductor component company Hangzhou Silan Microelectronics Co. (SHSE:600460, Financial). Given the continued geo-political tensions, the self-sufficiency drive in China continues to be a definite path for the country in its next stage of development. We believe Huafeng and Silan Micro stand to benefit from market share gains in this industry where foreign firms are still very dominant in China. To fund some of these new positions, we reduced our exposure to financials. We also reduced some exposure from holdings in communication services, including
Tencent (HKSE:00700, Financial) as it had held up relatively well compared to other platform companies, and redeployed capital towards other more attractively valued opportunities.
Outlook:
Looking ahead, we expect that China’s Zero COVID-19 policy will likely linger, and especially over the next quarter, and watching the overhang closely as it puts pressure on consumer sentiment. At the same time, the property market continues to be weak, although there are signs that the government is increasingly in the camp of loosening the very tight conditions of the property market. Given these two pressures, we believe there is more support for monetary easing in the second half of 2022 as China’s key goal is still both economic and political stability.
The larger unknown is how U.S. – China relations will pan out. While we see China becoming more willing to make concessions, we have not quite seen the same level of openness from the U.S. This lack of ability to ascertain U.S. – China politics will be a risk that will unfortunately be hard to manage for. Elsewhere, results remain largely in-line with expectations and continued healthy pace of growth is seen with some signs of margin erosion but managed relatively well. We remain more hopeful of an improvement in sentiment given still resilient earnings growth and an increased likelihood of policy easing ahead.
All performance quoted is past performance and is no guarantee of future results. Investment return and principal value will fluctuate with changing market conditions so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the return figures quoted. Returns would have been lower if certain of the Fund's fees and expenses had not been waived. Please see the Fund's most recent month-end performance.
Investments in Asian securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid and more volatile than securities markets in more developed markets. In addition, investments in a single-country fund, which is considered a non-diversified fund, may be subject to a higher degree of market risk than diversified funds because of concentration in a specific country.
