For the first half of 2022, the Matthews Asia Innovative Growth Fund returned -19.98%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned -16.14% over the same period. For the quarter ending June 30, 2022, the Fund returned -2.55%, while the benchmark returned -8.90%.

Market Environment:

The first half of the year was a challenging period. Elevated inflation data and diminishing consumer spending in many regions dampened global sentiment and sparked recessionary fears. While Asian equity markets endured choppy waters they performed well in the second quarter, experiencing less downside than commodity heavy, weak-performing EMEA (Europe, Middle East, Africa) and LatAm regions. In particular, Chinese equities saw a strong rebound—in both Hong Kong-listed stocks and local A-Shares. Chinese fiscal and monetary support, combined with more lenient zero-COVID policy implementation, a reduction of regulatory pressure on internet and platform monopolies and progress on real estate re-financing roadblocks enabled a rebound in sentiment and economic activity. Conversely, South Korea was a major market laggard followed by Taiwan, Japan and India. In terms of investing styles, Asian growth stocks continued to trail value stocks, especially in Japan, and small caps suffered more than their larger cap regional peers.

Performance Contributors and Detractors:

From a regional perspective, the Fund’s stock selection within China/Hong Kong and Singapore detracted the most to relative performance for the first half of the year. On the other hand, the Fund’s underweight allocation to South Korea and Taiwan contributed the most to relative performance. From a sector perspective, the Fund’s overweight and stock selection to higher growth communication services names detracted the most from relative performance for the period. On the other hand, stock section and overweight in consumer discretionary contributed the most to relative performance. Consumer discretionary is the biggest sector allocation and it is also where we believe innovation can flourish.

Turning to individual securities, Chinese consumer discretionary holdings H World Group, which is mainly engaged in multi-brand hotel operations, and Trip.com Group, a Chinese multinational online travel company, were the largest contributors to performance. Both companies performed well based on the expectation that China’s zero COVID policy will ease and travel activities will pick up in the country. On the other hand, communications services holdings Sea and Bilibili were among the largest detractors to performance. While Sea, an internet gaming and e-commerce company in Singapore, has achieved impressive track record in establishing sizable market share across different countries, increased uncertainty around their internet gaming revenue trends contributed to poor performance.

Bilibili, a Chinese video content company, continued to suffer from China’s policies to regulate the health and development of the country’s internet industry. However, the company’s operational metrics from user acquisition and engagement still trend positively and while we remain cautious about the ongoing regulations, we continue to hold Bilibili as the fundamentals of the company remain healthy and its position as one of the dominant players in its field has strengthened as a result of more regulatory scrutiny.

Notable Portfolio Changes:

During the second quarter, we initiated a position in Chinese health care company Innovent Biologics. Innovent, which develops and manufactures high-quality medicines for the treatment of major diseases such as cancer, rallied on positive sentiment around the likelihood it will get FDA approval for new therapy trials. Additionally, we initiated a position in Pinduoduo, a Chinese e-commerce platform offering a wide range of products including groceries, fashion, beauty and electronics. While Pinduoduo has been a loss-making company for most of its existence, it is now profitable and recent earnings results show improvement in its margin profile.

During the quarter we also exited a few positions including two Chinese stocks, Flat Glass Group which is principally involved in the research, development and sales of glass products, and Contemporary Amperex Technology, a lithium-ion battery manufacturer. In both cases we took the opportunity to take some profits and invest in other attractive Chinese companies. 

Outlook:

Looking ahead, we believe markets may see more volatility as they come to terms with the severity of Fed hikes, tighter global liquidity and protracted inflation.  That said, we believe that markets have priced in a substantial amount of uncertainty, especially within Asia and China, and not withstanding a sudden and severe downturn of global economic activity or a geopolitical shift, we believe there may be upside to come.

In particular, China should be positioned well for a pickup in domestic activity as the government is starting to support consumers and small and medium enterprises (SMEs) through gradual release of stimulus programs. Unlike the interest rate cycle in the West, interest rates are easing in China which may help lower the cost of capital for companies. In other parts of Asia, shopping mall operators in Southeast Asia stand to benefit from resumption of tourism activities. 

We continue to find many innovative companies in Asia at appealing levels today and the current levels continue to provide fertile hunting ground for companies that are innovating in areas such as business strategy, products and services, marketing and human capital.