For the year ending December 31, 2023, the Matthews China Fund (Trades, Portfolio) returned -19.22% (Investor Class) and -19.11% (Institutional Class), while its benchmark, the MSCI China Index, returned -11.04% over the same period. For the fourth quarter, the Fund returned -5.16% (Investor Class) and -5.16% (Institutional Class), while the benchmark returned -4.21%.
Market Environment
2023 was a disappointing year for Chinese equities and the Chinese economy overall. It's disappointing, in our view, not just in the sense of the underwhelming recovery of Chinese consumer spending post-COVID lockdowns but also due to the lack of any significant stimulus measures by the government. While the government started to gradually loosen nearly all property purchase-restrictions across most cities in China, the expectations of potential home buyers regarding future house prices and their own income levels have changed. As a result, these policy changes have barely helped to arrest the slump in the real estate market. As the year progressed, investors gradually gave up on the idea that the Chinese central government would step in to engineer a stronger consumption rebound.
The challenging real estate market and the soft consumption environment create a potential formula for deflation, in our view. From what we can see, many entrepreneurs, whose animal spirits were curbed during the COVID period, are now hesitating to start any new investments in this environment. From a geopolitical standpoint, the highly anticipated Biden-Xi summit in San Francsico in November didn't curb the ongoing concerns of international investors.
In terms of markets, quarterly results of leading Chinese companies, especially large-cap technology firms, seem to be hinting toward upward surprises in terms of topline revenue and earnings. During the last quarter of the year, information technology (IT) and utilities were the only positive sectors while real estate was weakest followed by consumer staples and communication services. Chinese small and mid caps ended lower but outperformed weak large and mega caps during the quarter.
Performance Contributors and Detractors
From a sector perspective, our lack of exposure to materials and stock selection within IT and consumer staples contributed the most to relative performance in 2023. Among individual holdings, the top stock performer was Pinduoduo (PDD, Financial), one of China's largest e-commerce platforms that started its businesses with a focus on lower-tier city, price sensitive consumers directly through its interactive shopping experience. PDD deliver strong results during the year in what has been a weaker e-commerce market in China. Gross merchandize value (GMV) growth and monetization for PDD has remained on track. PDD's strong execution continues to make it a standout in its peer group.
Tencent Music Entertainment Group (TME, Financial), the largest music streaming service entity in China, was another outperformer. We think the market is coming to terms with the steady decline of its social entertainment business being offset by what is a growing willingness of consumers to pay for music streaming services. Music services in China have an opportunity to realize higher profitability than global peers such as Spotify, in our view, because the top labels in China account for a smaller share of music streaming traffic and therefore don't have as much bargaining power in China as they do in the West.
On the other hand, stock selection in real estate, consumer discretionary and financials detracted from performance for the year. Turning to individual holdings, property developer CIFI Holdings (HKSE:00884, Financial) was among the biggest detractors to relative performance. CIFI's stocks only resumed trading at the end of September after a long suspension and its negative share price performance had an accumulated impact over the time it was suspended. China's largest food delivery service and internet platform company Meituan (HKSE:03690, Financial), a well held name in global portfolios, also detracted as a risk off appetite toward China led to a selloff. JD.com (JD, Financial) was the biggest detractor during the year. The e-commerce platform has generated concerns overs its growth prospects and has been weighed down by China's muted recovery. While internet platform companies' valuations have pulled back considerably, we believe they largely remain profitable and scale-oriented businesses. We continue to be overweight in consumer discretionary, led by an exposure in platform companies which we feel are very cheap and continue to deliver earnings improvement.
Notable Portfolio Changes
We streamlined the number of positions in the portfolio from 64 to 51 over the course of the year. Our overall exposure in mainland-listed companies has been reduced from around 38% in Dec. 2022 to 28% at the end of the year. Many smaller A-shares positions that were more expensive were exited from the portfolio as cheaper valuations, given the pull back, enabled us to build more into better quality holdings. In the more recent quarters, we have incrementally added to our positions in certain communication services names such as Tencent Music and social platform company Kuaishou Technology (HKSE:01024, Financial) (driven by low valuations as well as increased willingness among consumers to spend and pay for online services). We've also added to consumer names such as Yum China (YUMC, Financial) and Tsingtao Brewery (SHSE:600600_ (driven by the pull back of these names leading to attractive valuations for what are still renowned brands in China).
Outlook
2023 has been generally a challenging year for China. Despite the lifting of COVID restrictions in the country, the government's lack of stimulus generally led to weakening economic support. At the same time, property market woes continued, impacting sentiment and business confidence in the country. While more supportive measures have been rolled later in the year to address property market concerns, a meaningful inflection remains to be seen.
Looking ahead, we are cautiously looking for a stabilization of the deterioration in property markets. While we do not expect a significant warming of geopolitics, the ongoing current status quo of a more construction post-APEC posturing would be welcomed by the market. Valuations continued to trend down in 2023, and the broader China market hovers around similar levels as 2009 despite better quality businesses and earnings profile. We continue to believe that patience is needed in these market environments and, that it will ultimately pay off once the market turns. We intend to stick to our knitting and aim to deliver consistent growth-at-a reasonable price strategy for our clients.
View the Fund's Top 10 holdings as of December 31, 2023. Current and future holdings are subject to change and risk.
Average Annual Total Returns - MCHFX as of 12/31/2023
| 1YR | 3YR | 5YR | 10YR | SINCE INCEPTION | INCEPTION DATE |
|---|---|---|---|---|---|
| -19.22% | -18.78% | 0.62% | 1.83% | 7.22% | 02/19/1998 |
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.
