For the first half of 2023, the Matthews Asia Innovative Growth Fund returned -2.93%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned 3.19% over the same period. For the quarter ended 30 June 2023, the Fund returned -4.84%, while the benchmark returned -1.14%.

Market Environment:

The big event of 2023’s first half was undoubtedly China’s reopening—and more specifically, an economic rebound that has been slower to materialize than many investors anticipated. This especially weighed on consumer sentiment which remains relatively dour. Despite having ample cash balances, many Chinese consumers seem reluctant to resume spending at pre-pandemic levels. This has further complicated the government’s ability to effect meaningful changes as much of any fiscal stimulus would probably wind up in consumer savings accounts. China’s property market also remains weak and is adding to consumers’ sense of uncertainty—given many people’s wealth is tied to real estate. In addition, ongoing tensions with the U.S. weighed on sentiment and amplified uncertainty. Elsewhere, India remains a bright spot in Asia as it faces far fewer challenges in the current environment than China. South Korea and Taiwan have also outperformed as they are (to varying degrees) benefiting from the nascent artificial intelligence (AI) boom, high U.S. chip demand and overall strength in the American technology industry.

Performance Contributors and Detractors:

Regionally, our overweight and stock selection in China and Hong Kong were the biggest detractors to relative performance in the first half amid an environment of negative economic and consumer sentiment. Conversely, the Fund’s allocation to the U.S.—which consists primarily of technology companies—was the biggest contributor. These stocks benefited as investors sought exposure to Asia via non-China-domiciled companies in order to manage geopolitical concerns.

From a sector perspective, the Fund’s overweight and stock selection in consumer discretionary was the biggest detractor in the face of headwinds in China. Stock selection in communication services was also a big detractor though mitigated by our overweight allocation to the sector. Selections in health care, consumer staples and industrials were also detractors. Conversely, IT was the top contributor because of strength in hardware and digital services companies, and stock selection in real estate and our underweight and selection in financials also contributed to relative performance.

At the individual holdings level, sportswear giant Li Ning and e-commerce platform JD.com were among the weakest performers in the first half. JD.com has faced stiff pressure from rival platforms Alibaba and PDD Holdings (Pinduoduo), both of which are portfolio holdings. Given these dynamics, we chose to exit our position in JD.com. While Alibaba and PDD were bigger detractors in the period than JD.com we retained our positions in them because in our view they are more diversified and have higher potential growth than JD.com.

Conversely, U.S. tech giant NVIDIA, a leading beneficiary of the AI upswing, was the strongest contributor in the first half. Taiwanese technology companies Alchip Technologies and Taiwan Semiconductor Manufacturing Co. (TSMC) were also strong performers. Alchip has performed particularly well as the nascent AI trend has picked up steam. TSMC has benefited from the ongoing semiconductor boom—particularly as geopolitical tensions with the U.S. have driven many companies to source chips outside of China. TSMC also manufactures chips for NVIDIA and so is well-positioned for the expanding AI market.

Notable Portfolio Changes:

In the quarter, we initiated a new position in ASML Holding, a Netherlands-based semiconductor company. ASML derives most of its revenue from Asia where the majority of global chip manufacturing is located. It also has a very strong position in advanced chip-equipment production and is a beneficiary from some chip companies seeking to strengthen supply chains and move manufacturing away from China to the U.S. and Europe.

We also increased our exposure to PDD and Samsung Electronics. While the ongoing consumer malaise in China has challenged e-commerce companies and weighed on valuations, PDD is a company that is growing and taking share. We accordingly capitalized on its attractive valuation to add to our position. We increased our exposure to Samsung given the combination of its exposure to AI and its depressed valuation.

Conversely, we pared our exposure to Singapore-based Sea following a strong first-half performance in the stock. We trimmed our holding in H World Group given its higher valuation and as part of our ongoing reduction in our China exposure. We also hold Trip.com, which offers us similar exposure to H World though at a more attractive valuation and with, in our view, a better outlook. In addition to exiting JD.com in the period we also sold our holding in Li Ning.

Outlook: 

It seems clear to us that market movement in the second half will be heavily dependent on China’s performance. But China’s government has its work cut out. With the property market so depressed and consumers quite dour, it will be hard to kickstart the economy. That said, it also seems unlikely there is much room to the downside at this point—though we say that with caution as it seems many have called a bottom in China, only for it to sink further. Given the general sense of gloom surrounding China, it might not take much to spark a sentiment rally and turn things around. Time will naturally tell and we will continue monitoring how events develop in China.

Meanwhile, we remain positive on India. We are also positive on Indonesia in the long term but given there are currently relatively few innovative companies in Southeast Asia, our overall exposure to the region remains limited for now. We are also underweight in Taiwan. While fundamentals remain largely intact, strong performance has contributed to elevated valuations making Taiwan less attractive on a relative basis.

Uncertainty aside, we are finding innovative companies throughout Asia that are trading at attractive levels and will continue deploying our investment philosophy to uncover what we believe to be the next generation of companies able to innovate in business strategy, products and services, marketing and human capital.