For the year ending 31 December 2023, the Matthews China Dividend Fund returned -20.65%, while its benchmark, the MSCI China Index returned -11.04%. For the fourth quarter of the year, the Fund returned -8.78% versus -4.21% for the benchmark

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. Although the government did start to gradually loosen 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 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 have combined to 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 really impact the ongoing concerns of the market. And staying at the macro level, Chinese equites were a key exception in a November global equities rally that followed signals by U.S. Federal Reserve Chairman Jay Powell that the U.S. interest rate-upcycle was near an end. 

Performance Contributors and Detractors

An overweight to small- and mid-cap stocks detracted from relative returns in 2023 as these holdings were hurt by the weakness of China’s economic recovery. Stock selection in mega caps also detracted.  

At the sector level, stock selections in consumer discretionary, financials and real estate were the biggest detractors to total and relative returns in the period. On the flip side, stock selection in communication services was the top contributor. The portfolio’s cash position also helped cushion some downside during the year. 

At the holdings level, Xtep International, a sportswear company, was the worst performer and second-biggest detractor to relative returns. While the company’s business has been strong in recent years, the market has started to worry about the inventory condition of the whole industry and whether domestic brands will lose market share to global brands. Alibaba Group was among the biggest detractors to total return, largely as a result of the company abruptly walking back a plan to separate and spin off its cloud business. China Education Group, a provider of vocational education services, was another detractor after the company reported increased impairment losses, narrowing margins and weaker profitability in its full-year results.

On the other hand, CITIC Telecom International Holdings, the parent company of Macau’s leading fixed line and mobile telecom operator, was the top contributor to total and relative returns during the year, as the company maintained a stable business operation and a high dividend payout policy. Yangzijiang Shipbuilding Holdings was another top contributor, as the company continued to win orders for new ships and new environment standards are seeming to prolong the current global ship ordering cycle. Miniso Group, a discount retailer with worldwide presence, also contributed although its share price experienced high volatility during the last quarter as its valuation became rich. 

Notable Portfolio Changes 

We initiated a position in Fuyao Glass Industry Group, a leading automotive glass manufacturer, in the last quarter of the year. We believe the company is well positioned as new electric vehicles (EVs) continue to include more glass content compared with traditional vehicles. In addition, we added a position in Kanzhun, a high profile recruiting platform. Although we have not seen a clear recovery of hiring across all segments in China, a feature of Kanzhun’s services—enabling hiring managers and job applicants to communicate online—makes it especially attractive to younger segments of the workforce. 

In contrast, we sold our position in China Vanke, a real estate developer, given the significant difficulties that these firms face in trying to sell new residential properties and monetize other commercial real estate assets, such as shopping malls or warehouses, in such an uncertain environment. We also exited OPT Machine Vision Technology, a supplier of factory equipment, as the company disappointed in securing new orders in its new EV batteries business while its traditional consumer electronics customers didn’t bring in much growth.

Outlook 

We remain cautious on Chinese equities. Both domestic and international investors have had their confidence severely tested over the last three years. Unlike many other equities markets, there is no “natural” inflow into China’s market through pensions or retirement savings plans. That’s left only selected groups of companies with strong cash flow and balance sheets being active in the market, buying back their own shares. 

Among the traditional drivers of Chinese economic growth, aside from real estate, the export sector is still demonstrating some strength. However, as China grows its share of global industrial output, it raises the specter of more trade frictions alongside continuing U.S. tariffs. In terms of consumption, the third economic driver, Chinese consumers are likely to continue to behave very conservatively due to a lackluster employment market and bleak outlook for income growth. Industries with high paying jobs have unfortunately become casualties of tightened regulation and some have been subject to pay-cut directives from the government. 

Chinese policymakers, in our view, have not yet realized the real threat of deflation to the economy. Although we don’t fully subscribe to the theory of a “Japanification” of China, we believe the government needs to do a lot more to avoid this trap and the risk of a “lost decade.”