For the year ending 31 December 2020, the Matthews China Dividend Fund returned 24.30%, while its benchmark, the MSCI China Index, returned 29.67%. For the quarter ending 31 December 2020, the Matthews China Dividend Fund returned 12.15%, while its benchmark, the MSCI China Index, returned 11.21%.

Market Environment:

Following some early missteps in addressing the pandemic, Chinese authorities acted decisively, limiting internal travel and controlling its borders while working with world health organizations to control the outbreak. In addition, policy actions meant to assist small and medium-size enterprises were implemented including an increase in loan quotas, lowering of borrowing rates, a delay in loan repayments and value added tax (VAT) relief. The result was an early 2020 outperformance of Chinese equities which added support to neighboring country markets.

The second quarter of 2020 was lackluster even though anecdotes from our local offices and official economic data implied that recovery was well under way, however, the uncertainty around the national security law in Hong Kong has shadowed the performance of Chinese equities, especially the market in Hong Kong.

Chinese equities posted strong returns in the third quarter but most of those gains were registered in the first two weeks of the quarter—reflecting increased tensions between the U.S. and China. Nevertheless, consumer discretionary stocks (autos, travel and retail) were the strongest performers due to economic data pointing to a full recovery underway. Chinese equities were strong going into the last quarter of 2020, however, the surprising cancellation of Ant Financial’s IPO caused investors to worry about China’s regulatory risk towards giant internet companies, causing overall sentiment to wane somewhat.

Performance Contributors and Detractors:

For the full year of 2020, the Fund’s underweight in the financials sector and security selection in the real estate sector contributed the most to performance. On the other hand, security selection in communication services and consumer staple sectors detracted from Fund performance. Our total-return investment approach provides the flexibility of investing in both dividend-paying stocks and dividend growth stocks. To achieve a balance between dividend growth and current high yield, we maintained certain high dividend yield stocks such as telecom operators. However, these names are likely to underperform during a rally driven by ample global liquidity.

During the fourth quarter, SITC International Holding, a shipping company with focus on intra-Asia routes, was a contributor to Fund performance. Container shipping rates rose rapidly around the Christmas shopping season which benefited the company. We believe SITC is also well positioned to benefit from regional trade among Asian countries boosted by the Regional Comprehensive Economic Program (RCEP). Another contributor was Leader Harmonious Drive Systems, the precision parts company we added during the third quarter, as the market started to realize the company’s competence on the global stage. Cathay Media and Education Group was also a contributor, as it completed an acquisition of an after school tutoring service company, further expanding its art and performance education business into a bigger potential market.

On the contrary, medical equipment maker AK Medical was a detractor during the quarter, as the market worried that the centralized procurement of AK Medical’s products could depress its margin. We are closely monitoring the situation. Shimao Services Holding, a residential property manager, was another performance detractor. We participated in the company’s IPO due to its reputation of quality service. However, in a relatively short period of time, the market was flooded with many property managers’ IPO, and when negative news about its parent company’s bad acquisition emerged, Shimao’s shares sold off. In our view, this has very little impact on the company’s own operation, thus, we added to our position during the market selloff. HKBN, the broadband operator in Hong Kong, was also a detractor during the quarter. The company reported dismal outlook as its customers have been significantly impacted by COVID-19. However, we are still confident in HKBN’s management to maintain its growth longer term.

Notable Portfolio Changes:

During the fourth quarter, we re-initiated positions in Postal Saving Bank of China.  As China’s economy stabilizes further, we believe the asset quality of the banking sector should also improve. We also initiated a position in Travelsky Technology, the dominant airfare ticketing agency in China. Although its earnings had been impacted by bad debt incurred by one of its customers (a troubled airliner in financial distress), we believe it is largely a one-off situation and should not impact its fundamentals. As Chinese and global air travel could improve further into 2021, we think TravelSky should be well positioned to ride the recovery.

In addition, we rotated capital from Zhong Sheng Group to China Yongda Auto. As the valuation gap between these two companies widens, we think there is more upside potential for Yongda Auto to catch up as the market may be late to recognize its improvements in operations. We also exited our position in China Tower as we were concerned that it could be impacted by Donald Trump’s executive order to exclude Chinese companies with a military link, as the largest shareholders of China Tower are China Mobile, China Telecom and China Unicom. We also exited KWG Group as we viewed the company’s further upside was limited going forward after it spun off its property service arm.

Outlook:

Unlike many developed economies’ unlimited quantitative monetary easing policy, China’s monetary aggregates have been balanced for several months, offering Chinese policymakers a future cushion to stimulate the economy, if needed. At the same time, China’s rebounding economy and solid mid-teens consensus earnings growth estimates should support current valuations.

China’s newly released five-year plan could support businesses benefiting from the “dual-circulation” announcement focused on domestic demand and self-sufficiency in key areas of technology, innovation, health care and the digitalization of its economy. Meanwhile China has not given up its participation in the global economy—just in the last quarter alone, China concluded two key trade negotiations, RCEP (Regional Comprehensive Economic Cooperation) with mostly Asian counties and a bilateral investment agreement with the European Union.  The investment agreement with the European Union includes for the first time, specific language to rein in behavior of State Owned Enterprises. This shows quite significant progress of the long waited reform. Geopolitical factors, especially U.S. – China relations under the Biden administration, will also influence the unfolding of Asia market in the new year. We believe a total-return approach, balancing dividend income with dividend growth, should continue to help us uncover attractive market opportunities in 2021.