For the quarter ending March 31, 2023, the Matthews China Fund (Trades, Portfolio) returned 0.41% (Investor Class) and 0.48% (Institutional Class), while its benchmark, the MSCI China Index, returned 4.71%.
Market Environment:
Chinese equities grinded higher, albeit with considerable volatility, even after posting some of the strongest results within global markets in the final quarter of 2022. The country’s lifting of its long-standing COVID restrictions allowed for a ‘more normal’ Lunar New Year celebration helping to boost consumption indicators, especially those focused on domestic tourism, local services and entertainment. However, spy balloons, bilateral tensions and a spike in U.S. interest rates spurred profit taking in Chinese equities in February which relinquished almost the entire year-to-date gains. In March, cross-strait tensions seemed to fade, and the Chinese government showed strong support for gaming and internet sectors along with announcing state-owned enterprise (SOE) reforms and additional fiscal stimulus which combined improved local sentiment causing A-share small-cap equities and large Hong Kong-based platform companies to bounce higher.
In the first quarter, large-cap platform companies within the information technology and communication services sectors lead the MSCI China Index higher while health care and real estate—especially smaller caps lagged.
Performance Contributors and Detractors:
The portfolio’s overweight and stock selection within the information technology and an underweight and stock selection within the consumer staples contributed to relative performance. On the other hand, the portfolio’s allocation and stock selection within the communication services detracted from performance. An overweight and stock selection within the consumer discretionary sector also detracted as some of the holdings announced weaker-than-expected numbers in their most recent earnings and hindered performance.
Among individual securities, KE Holdings (HKSE:02423, Financial)—China’s leading online real estate platform—was a top contributor to both absolute and relative performance. The company has been benefiting from expectations of recovering real estate sales in China as the country’s reopening unfolds. KE Holdings is also continuing to benefit from existing home sales (which are more secular in nature driven by household formation and upgrading trends) rather than new home sales (which could be more speculative in nature). We continue to see this holding as one that would benefit from increased real estate trends this year.
On the other hand, JD.com (JD, Financial)—China’s leading e-Commerce platform company known for its authentic products as well as fast and efficient product delivery—was among the weakest performers. The company announced weaker-than-expected numbers in its most recent earnings and provided a conservative outlook for the first half of the year. JD.com’s announcement of additional investments it may make in order to fend off e-Commerce competition in the country also caused market worries. However, we continue to find the company’s value proposition compelling in China’s e-Commerce industry. JD.com has built a moat around product quality and logistics network, which are hard to replicate and may continue to benefit the company as the business moves into other areas, such as online pharmaceutical distribution.
Notable Portfolio Changes:
During the first quarter, we took the opportunity to consolidate the portfolio from 64 names at the end of Dec 2022 to 52 at the end of March 2023. We consolidated many small A-share names that were under 50 basis points (0.50%) in position, including Anjoy Food Group (SHSE:603345, Financial), Beijing Huafeng Test and Control Technology (SHSE:688200, Financial), Cambricon Technologies (SHSE:688256, Financial) and Gigadevice Semiconductor (SHSE:603986, Financial). Many of these A-share positions continue to be relatively more expensive and operate in a landscape where competition continues to be rather intense.
We also added a few holdings including Ping An (SHSE:601318, Financial)—the leading financial conglomerate in China with businesses in life insurance and banking and Zhejiang Supcon Technology (SHSE:688777, Financial), an industrial automation leader managing large scale factory automation projects. Ping An’s aggressive cost cutting during the pandemic resulted in a much healthier cost base. We believe China’s reopening will help with the company’s business operations and activity as life agents are able to regain mobility and sell to clients. Zhejiang Supcon has been steadily gaining both domestic and international market shares and is actively growing from selling hardware to also selling software to help digitize the next generation of factories.
Outlook:
China’s reopening continues to be bumpy with some sectors such as consumer discretionary and communication services (advertising) recovering ahead of others. We continue to monitor China’s property market developments as this is key in ensuring growth stability within the country. So far, a gradual, slightly better-than-expected property sector recovery has been seen on the ground. Industrial recovery has been weighed down by underperformance in the renewables sectors (EV/solar/wind) so far. We feel that investor sentiment has been overly bearish on concerns about slowing demand and oversupply. This continues to be a secular opportunity for growth and is key in China’s carbon neutrality transition. Platform companies in China continue to experience market sentiment volatility given varying geopolitical reactions. However, valuations are cheap, and any signs of warmer sentiment benefits a recovery in the stock prices of these platform companies more meaningfully.
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.
