For the year ending 31 December 2020, the Matthews Asia Small Companies Fund returned 46.12%, while its benchmark, the MSCI All Country Asia ex Japan Small Cap Index, returned 26.60%. For the fourth quarter, the Fund returned 24.27%, while its benchmark returned 19.72%.

Market Environment:

Equities across Asia were volatile in the year, but broad market indexes tracking the region ultimately generated attractive returns. Global markets fell in the first quarter, as worries surrounding the spread of COVID-19 moved from China throughout Europe to the U.S. and then back to South Asia, including India. Fears of a global growth slowdown turned into reality as governments worldwide began to implement different versions of “shelter in place” to contain the movement of the virus. But central banks globally, led by the U.S. Federal Reserve, unleashed powerful, and largely effective, monetary stimulus. Many governments also unveiled meaningful fiscal stimulus. Both those actions helped ease worries about a crippling and sustained global recession. They also provided cover for many emerging markets (EM) to undertake their own monetary and fiscal stimuli thereby supporting their economies.

In the third quarter, economic recovery and improved sentiment began to take hold as major economies continued to relax COVID-19 lockdown restrictions even further. China’s V-shaped recovery in manufacturing along with a steady recovery in domestic consumption brought some normalcy to daily life. EM currencies rallied slightly against the U.S. dollar in the third quarter, acting as a slight tailwind for EM equities. Growth stocks outpaced value and small caps outperformed large caps. The fourth quarter saw further economic strengthening. Cyclical stocks in beaten-up or export-driven markets such as Indonesia and South Korea rallied most in the fourth quarter, while markets that experienced early recovery like China, Japan and India lagged slightly. Market strength gained momentum following the U.S. Presidential elections in November as markets hoped for less confrontational U.S. – China relations, combined with an announcement of several approved COVID-19 vaccines that were due for distribution early in 2021.

Performance Contributors and Detractors:

Stock selection in China/Hong Kong was a notable contributor to performance for the year. As the economic recovery continued to broaden in the year, small companies, especially in the health care and technology space, did well. On the other hand, stock selection and an underweight to South Korea was a detractor. South Korea’s broader markets, led by cyclical sectors such as materials, shipping and shipbuilding rallied late in the year on improving sentiment toward global exports and trade. Our underweight worked against us in this environment.

From a sector perspective, stock selection in information technology was a notable contributor. The expansion of China’s local supply chain development especially in areas such as semiconductors and industrial automation has aided stock performance. Smaller companies are well positioned to participate in this growth, bringing innovative new approaches to existing customer needs. On the other hand, stock selection in health care was a detractor, even though our overweight to the sector was a contributor. While our health care holdings generated attractive total returns in aggregate, they trailed the returns of the benchmark constituents within the sector. We continue to like the long-term prospects of our health care holdings.

Among indivdual stocks, Silergy Corp was a notable contributor. While listed in Taiwan, Silergy is a truly global company with an edge in China. The company designs mixed-signal and analog power management integrated circuits that are used in industrial, consumer, computing and communications. On the other hand, a detractor was property developer Times China, which focuses on developments in the Greater Bay Area in Guangdong province. This area has been earmarked for further development in high-value-adding sectors such as the technology and financial industries, and is likely to see growth in infrastructure connectivity over time. The real estate industry has been sluggish as the pandemic has disrupted sales in China, but we continue to like the company’s long-term prospects in land banking, as well as its attractive valuations.

Notable Portfolio Changes:

During the fourth quarter we have initiated a new position in Formosa Sumco Technology Corporation, a Taiwanese semiconductor wafer manufacturing company. The company derives the majority of its revenues from 12-inch wafers while also having meaningful exposure to the 8-inch wafers. Its main customers include foundry and memory companies operating in Taiwan and China. The demand for wafers is expected to continue to recover in 2021 and beyond, providing support to top and bottom line growth. At the same time the industry is also consolidating, thereby potentially bringing in capacity addition and pricing discipline. We find the company reasonably valued.

We also initiated a position in Malaysian home improvement retailer Mr. DIY through the IPO process. Mr. DIY is the largest player in the industry with about 30% market share in an end market that is growing. The company’s value proposition is that it has an offering that is attractively priced at convenient locations in a store format that has a large number of items per store. The company continues to drive sales growth through both new store openings as well as by delivering good like-for-like sales growth, which translates into attractive profit growth driven by its efficient operations. Two new formats—the discount retail format, MR DOLLAR and value-for-money toy store, MR. TOY—offer further growth options.

Outlook:

Looking ahead, uncertainty remains in terms of the pace of Asia’s economic recovery. Given the uncertainty of how quickly vaccines can be distributed, how quickly daily patterns may return to normal remain unknown and the strength of the economic recovery in different markets where we invest may not be immediately evident. Valuations for Asia ex-Japan equities are above their historic averages and in some areas of the market, we believe investors have already priced in a high level of anticipated future growth. All of these emphasize the importance of investing with a long-term view.

At the same time, we see many reasons for optimism. There are three important drivers for equity prices—growth, valuation and liquidity. From a growth perspective, Asia is on a path to economic recovery and the sheer size of the consumer base in Asia works in its favor. Valuations for Asia ex-Japan equities rose in 2020, so there is less valuation support for the broader market, but we continue to see pockets of opportunity. Finally, turning to market liquidity, we find good liquidity across Asia. We believe the confluence of these drivers will support medium to long-term growth across many parts of Asia.