For the quarter ending 30 September 2023, the Matthews Asia Sustainable Future Fund returned -1.00%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned -3.22%.

Market Environment:

During the quarter, U.S. 10-year bond yields rose meaningfully on market concerns over interest rates staying higher for longer. With materially higher yields on offer, equity market relative valuations in relation to bonds deteriorated, leading to weak equity market performance toward the end of the quarter. Oil prices also firmed up on the back of concerted efforts by OPEC to cut supplies.

India was the best-performing major market in the region during the quarter while Malaysia, a smaller market, did even better. South Korea, Taiwan and China/Hong Kong were the worst-performing major markets while the Philippines and Indonesia also posted declines. From a sector perspective, energy and consumer discretionary were the best-performing sectors while real estate and information technology (IT) were the worst performers.

From a currency perspective, only the Hong Kong dollar in the region appreciated against the U.S. dollar during the quarter. The Chinese renminbi, Malaysian ringgit and the Indian rupee, which all depreciated against the dollar, were among the other best-performing currencies on a relative basis. The Taiwanese dollar, the Indonesian Rupiah and the Thai Baht were among the worst performers.

Performance Contributors and Detractors:

From a country perspective, our stock selection and overweight to India, and stock selection and underweight to Taiwan and South Korea were the biggest contributors to relative performance in the period. On the other hand, our stock selection in China was the biggest detractor from relative performance.

At the sector level, stock selections in industrials, financials, health care and real estate were the top contributors to relative performance. In contrast, an underweight and stock selection in consumer discretionary and stock selection in information technology (IT) and consumer staples were the biggest detractors. Our lack of exposure to energy also detracted.

From a stock perspective, Ecopro BM was the biggest contributor to total and relative returns in the period. The South Korean cathode maker gained on the back of strong contract backlog buildup on account of orders from U.S. original equipment manufacturers (OEM) to South Korean battery cell makers. We significantly trimmed our position during the quarter as the stock performed very well. Elite Material, a Taiwanese maker of key raw materials that go into printed circuit boards used in AI servers, was also a top contributor.

In contrast, Samsung SDI, a South Korean battery maker, was the biggest detractor to total and relative returns in the quarter on near-term worries about potential weakness in European electric vehicle (EV) sales in general and in sales of the company’s key customers in particular. We continue to take a positive view of the long-term technological capabilities and prospects of Samsung SDI’s business. JD Health, a leading Chinese online pharmacy and medical services player, was also a large detractor amid general softness in the large-cap China internet space over concerns about weak consumer confidence. The stock also experienced a negative high-base effect from its strong performance in the second half of 2022. We expect a gradual recovery in Chinese economic fundamentals and consumer confidence and expect JD Health to do well over the long term. China-based Flat Glass fell on the back of general weakness in the solar-supply chain amid market concerns over the 2024 demand outlook following better-than-expected 2023 demand out of China, and the pace of capacity addition in the industry. We remain positive on the long-term growth prospects for the industry and Flat Glass’s leadership position within it.

Notable Portfolio Changes:

There were no additions during the quarter. We exited small positions in Summarecon Agung, an Indonesian property developer, and CSPC Pharmaceutical, a Chinese pharmaceutical company, as we found better use of capital elsewhere.

Outlook:

The Federal Reserve’s interest rate strategy and expectation of its evolution were the most important variables impacting the performance of emerging markets over the last few quarters. Notwithstanding the recent increase in 10-year bond yields, we believe the Fed is near or at the end of the interest rate hiking cycle so the focus will now shift to assessing the cumulate impact of all the rate hikes on economic growth prospects over the coming quarters.

Our focus on the end of 2023 and into 2024 will be on assessing how China’s economic recovery and growth prospects play out and how they might affect the dynamics of other emerging markets. In addition, OPEC’s efforts to keep oil prices high will require ongoing, careful monitoring.

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, alongside relatively attractive valuations, should potentially lend support to better equity performance against developed markets compared with the last decade.

Finally, we view sustainable investing as a synonym for long-term investing. Our approach focuses on investing in companies that are well-positioned to embrace global, multidecadal trends, including addressing critical challenges like climate change and inclusive development. These companies also often tend to be good in identifying and proactively addressing long-terms risk to their businesses. Emerging markets, we believe, are key destinations for sustainable investment themes that offer attractive opportunities for alpha generation.