The Matthews Asia Innovative Growth Fund was launched on 23 March 2021. Since inception, the Fund returned 4.40%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned 2.66% over the same period. This is the first commentary for the Matthews Innovative Growth Fund which seeks to invest in innovative quality companies that can benefit from structural growth trends and large addressable markets across Asia. We aim to invest in companies that are capable of showing sustainable growth based on their fundamental characteristics.

Market Environment:

The first six months of the year has been a volatile period for Asian equity markets. There have been two driving forces going head-to-head during the first half of the year—the ongoing recovery of the economy with improving corporate earnings versus increasing regulatory headwinds. During the first quarter of the year, the market sold off on the back of increasing regulatory challenges, especially within the Chinese internet and education sectors. During the same period equity markets rotated from growth to value.

During the second quarter, growing concerns over inflation and potential interest rate hikes began to fade. As companies reported earnings, the market started to recover as investors shifted their attention back to fundamentals. We might see these two forces continue to pull the market in either direction during the next few quarters. Toward the end of the second quarter, concerns over the rise of the Delta variant of the COVID virus spooked investors again, causing equities to give up some of the gains made during the quarter.

Performance Contributors and Detractors:

The Fund outperformed its benchmark since its inception on 23 March 2021 through June 30, 2020 driven by strong stock selection.

During the reporting period, the Fund’s health care and communication services sectors were the largest contributors to relative performance. Among individual holdings, Singapore-based gaming and e-commerce company Sea Ltd. was among the largest contributors to the Fund’s absolute and relative performance. Sea’s dual engines of growth—online gaming and e-commerce—continued to show healthy growth, contributing to its strong performance during the period. Among individual health care companies, Wuxi Biologics Inc., a CDMOs (Contract Development and Manufacturing Organization) that helps many of large global and smaller regional pharma companies get drugs developed, was the biggest contributor to absolute performance during the quarter. Chinese information technology company Silergy Corp. was another holding that performed well during the quarter. Silergy, which mainly makes power management analog semiconductors, is in our view well positioned to benefit from the import-substitution trend we have been seeing in China, as the company continued to take market share away from other global semiconductor companies. We expect this trend to continue in coming years.

On the other hand, Chinese e-commerce companies were among the laggards in the portfolio. Both Alibaba Group Holding Ltd. and JD.com, Inc. were among the detractors to absolute performance during the second quarter. The Chinese internet sector overall remained under pressure from increasing regulatory headwinds, as the Chinese government continued their investigation focusing mainly on consumer privacy and data protection. The sector will continue to be under pressure as the current investigation is on-going. However, we expect the market to reflect each company’s fundamentals when the investigation is complete. The underlying growth and earnings of Chinese internet companies have been very resilient so far and valuations are now looking very attractive. We continue to be very selective in this sector and will continue to focus on fundamentals.

Notable Portfolio Changes:

The Fund maintains an overweight in health care and consumer discretionary sectors, and started a position in Maruti Suzuki India Ltd., a subsidiary of the Japanese automotive manufacturer Suzuki. Maruti Suzuki has been introducing energy efficient models in India while also developing hybrid models. We believe that Maruti Suzuki can make a big shift to hybrids and then to electric vehicles in coming years. We have reduced our exposure to areas that are highly sensitive to the current regulatory environment. During the quarter, we exited our position in China’s Tal Education Group, which offers after-school education for students in primary and secondary school. Tal Education faces uncertainty that may directly impact their revenue in the face of a potential government crackdown on for-profit education. We will continue to monitor this space until the regulatory framework becomes more transparent.

Outlook:

Looking ahead, while there is some risk of the Delta variant threatening economic recovery in some countries, the COVID vaccination programs across Asia are also picking up pace. Regulatory environment concerns will likely persist during the second half of the year, and we will continue to monitor this situation very closely.

With the on-going concerns over the regulatory environment in China, valuations for innovative companies continue to look attractive in our view. We are also excited to see the pace of innovation picking up across Asia, and we are seeing more “unicorns” going public beyond China, particularly in South Korea, India and Indonesia. We find many innovative companies in Asia at appealing levels today and the current levels continue to provide fertile hunting ground for companies that are innovating in areas such as business strategy, products and services, marketing and human capital. We continue to see many structural growth opportunities driven by rising disposable incomes and growing demand for improving productivity.