The Matthews Asia Sustainable Future Fund was launched on 21 July 2022.

Market Environment:

In 2022, the U.S. and many other parts of the developed world saw high rates of inflation that they hadn’t experienced since the 1980s. The U.S. Federal Reserve increased the Fed funds rate seven times last year after guiding for a transitory inflation for much of 2021. This led to strong U.S. dollar performance that peaked around the end of the third quarter.

Inflation was less of a challenge in key emerging markets like China, partly because of suppressed economic activity resulting from China’s zero COVID policy which was in place for much of 2022, and because where inflation was elevated, a number of central banks proactively addressed it by sharply increasing rates.

Nonetheless, Asia emerging market currencies were not completely immune to the impact of a very strong greenback. The Hong Kong dollar, Thai baht and Malaysian Ringgit were the least affected against the dollar last year while the Indian rupee, Taiwanese dollar and Philippine peso were the worst performers. For perspective, some major developed market currencies, such as the Japanese yen and British pound, fared worse than some Asia market currencies.

Since the Fund’s inception, Thailand was the best-performing Asia emerging market, followed by Malaysia and the Philippines. On the other hand, Taiwan, China/Hong and South Korea were the worst-performers. These poor performers turned in robust performances in the fourth quarter as they were aided by China’s lifting of its pandemic restrictions.

Performance Contributors and Detractors:

On a country basis, our stock selection in Taiwan was the biggest contributor to relative performance since the Fund’s inception. Our overweight to India and allocation to China/Hong Kong were the next biggest contributors to relative performance though this was mitigated by our stock selection in India and China/Hong Kong which detracted from performance.

From a sector perspective, stock selection in consumer discretionary was the biggest contributor to relative performance. Our underweight and stock selection in information technology was a large contributor and our overweight and stock selection in real estate was also a positive. On the flip side, our stock selection in industrials and financials were the biggest detractor from relative performance.

At the stock level, as China’s zero-COVID policy was lifted toward the end of 2022 our Chinese portfolio holdings in general and holdings in JD Health and Full Truck Alliance in particular rebounded strongly and contributed positively to relative performance. JD Health, an internet health-care platform, was the top performer as it benefited from a surge in demand for health-care products and services during the latest wave of COVID and also on expectations of favorable regulatory changes. Full Truck Alliance, an online freight platform, gained as a result of China reopening expectations and rebound in economic activity that would be beneficial to its revenue growth and also on expectations of movement restrictions that constrained trucking industry being lifted. Our Indian holdings also benefited from the normalization of economic activity in the country. Phoenix Mills, a retail mall operator, and Lemon Tree Hotels were among top contributors amid stronger pricing and/or higher sales in these consumer segments compared with pre-pandemic levels. Conversely, electric vehicle (EV) supply-chain names underperformed toward the end of 2022 on worries about developed world economic growth potentially softening in 2023 at a time when the EV industry is rapidly increasing production capacity. South Korean EV component company Solus Advanced Materials, which has manufacturing operations in Europe, detracted from performance amid concerns about its cost competitiveness given a significant increase in energy prices in Europe. We retain a positive view on the long-term demand trends for the EV industry and the competitiveness of Asian battery cell makers within it.

Notable Portfolio Changes:

We did not initiate any new positions during the fourth quarter of 2022.

Outlook:

The Fed’s interest rate strategy and the market’s expectation of its evolution continue to be the most important variables impacting the near-term regional, sector and currency performance in emerging markets. We expect the impact of Fed’s actions in 2023 to be less than it was in 2022 as the tightening cycle enters late stages. In addition, we are also wary of the cumulative impact of the Fed’s interest rate hikes on U.S. and developed world economic activity.

Our other key focus in 2022 was the evolution of China’s zero-COVID policy and its impact on economic activity in the country. This has largely been resolved given the unexpected lifting of most COVID restrictions in China in late 2022. Elsewhere, Russia’s invasion of Ukraine and its effect on energy prices— alongside OPEC’s efforts to keep the prices high—needs careful watching, especially as Chinese economic activity is likely to pick up as 2023 progresses.

Over the coming years, we expect the emerging markets gross domestic product (GDP) growth-differential with developed markets to improve from a 23-year low reached in 2022. This development, alongside relatively attractive valuations, should potentially lend support to better equity performance against developed markets compared with the last decade.

Companies that address critical challenges, such as climate change and inclusive development, will continue to thrive, in our view. And for investors interested in sustainability themes, including reducing carbon emissions, alleviating poverty and creating greater financial inclusion in the developing world, Asia emerging markets are a key investment destination. To tackle sustainable themes globally, we believe we need to include the world’s most populous economies, many of which lie in Asia.  As the post-COVID global economic recovery matures and markets contend with macro headwinds and volatility, we believe there are attractive opportunities for alpha generation throughout our large, diverse, sustainable investment universe.