For the year ending December 31, 2022, the Matthews Asia Innovative Growth Fund returned -24.74%, while its benchmark, the MSCI All Country Asia ex Japan Index returned -19.36%. For the fourth quarter of the year, the Fund returned 9.09% versus 11.43% for the benchmark.

Market Environment:

2022 was another challenging year for Asian markets, particularly Taiwan, South Korea and China—the latter as the country’s ongoing zero-COVID policy materially impacted the domestic economy. Further pressuring China’s markets were ongoing concerns about the government’s regulatory interventions across sectors including technology and health care, as well as the challenges facing the country’s real estate sector. This combination weighed on investor sentiment and, in turn, market returns throughout the year.

Fortunately, starting in December, China’s government started to rapidly dismantle its zero-COVID policy and announced the reopening of its borders to international travel. We believe this will lift a major market—and economic—overhang as 2023 begins.

There were bright spots in 2022, including Indonesia’s and India’s markets, both of which were quite resilient given their relatively lower exposure to technology and lack of regulatory pressure. Investors seemed to view both markets as relatively stable havens, which helped deliver more moderate returns—4.23% for Indonesia and -7.49% for India.

Performance Contributors and Detractors:

From a regional perspective, our stock selection in China/Hong Kong was the biggest detractor to performance during 2022 as China’s zero-COVID policy pressured business activity and consumer spending. Our underweight and stock selection in Singapore also detracted from performance. Conversely, the Fund’s overweight to India, as well as stock selection, was the biggest contributor to performance. Our underweight to technology-heavy Taiwan was also a positive contributor.

From a sector perspective, the Fund’s stock selection in communication services detracted the most from performance. Stock selection in health care was also a detractor as was stock selection in industrials. On the other hand, the Fund’s underweight to information technology (IT) was a positive contributor, while the Fund’s stock selection in financials was a top contributor as companies in the sector benefited from global interest-rate hikes. By the end of the year, both IT and communication services had experienced a rerating as many economies reopened and post-pandemic recoveries began.

At the holdings level, electronic vehicle (EV) maker XPeng was the biggest detractor as the company faced intensifying competitive pressures in a robustly growing industry. Singapore-based e-commerce platform Sea was another big detractor. It was a casualty of 2022’s technology downturn which especially punished companies without profits, like Sea. Long term, we maintain our conviction in Sea given its already dominant market share in Southeast Asia and its growing share in other emerging markets like Brazil. Conversely, Trip.com and Pinduoduo were among the top performers. Trip.com, a leading online travel agency in China, may be a major beneficiary as China lifts its pandemic restrictions policy. Chinese e-commerce platform Pinduoduo is similarly poised to benefit from China’s reopening. Having cut costs during the pandemic, Pinduoduo is well-positioned to expand margins and improve profitability as consumption rebounds, in our view.

Notable Portfolio Changes:

Over the course of the year, we exited positions including XPeng given the growing headwinds facing the company. We also pared our exposure to Indian and Indonesian banks, such as ICICI Bank, Bajaj Finance, Bank Rakyat Indonesia and Bank Mandiri, where valuations have risen materially. We used this capital to increase our exposure to technology and semiconductor names, including Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung Electronics, where valuations became highly compelling amid the broad technology downturn.

The delisting risk to Chinese stocks trading on U.S. exchanges has materially decreased after the U.S. Public Company Accounting Oversight Board (PCAOB) last year gained full access to the audit books of these firms. Accordingly, we shifted some capital from China local shares to Chinese American Depositary Receipts (ADRs) given ADRs can be much more liquid. 

Outlook:

We are constructive on the broad outlook for 2023. As China shelves its zero-COVID policy, we expect consumption to pick up and overall sentiment to improve—though we expect bumps along the road to recovery. For example, normalization will pressure China’s health-care system as COVID rates rise. 

We also believe the regulatory outlook has improved in China. Following several years of stringent crackdown, we are seeing positive signs the government is signaling its understanding of private companies’ important role—especially technology companies, which create many high-quality jobs, which China needs. Further, China seems to be making headway in stabilizing its real estate market.

We are also increasingly seeing signs of a different interest-rate cycle in Asia, especially China. The U.S. faces a tougher inflation fight than China, which could result in lower interest rates and more stimulus in China and lead to some decoupling between the two economies in 2023.

The combination of relatively lower (and therefore, more compelling) valuations, improved investor sentiment and positive economic and regulatory outlooks give us relative optimism about the year ahead. That said, investing is hardly ever without its surprises—and we will remain ready to reposition the portfolio accordingly, should developments warrant.