For the first half of 2022, the Matthews Pacific Tiger Fund returned -18.95%, 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 -9.44%, while the benchmark returned -8.90%.

Market Environment:

The first half of the year was a challenging period. The Asia ex Japan region experienced a largely similar rate of decline in the first and second quarters but the factors influencing the decline were quite different. In the first quarter, Chinese equities and the financials sector were the worst performing but recovered nicely to be the best performing in the second quarter. On the flip side, the contributions of Vietnam, Taiwan and South Korea deteriorated in the second quarter with latter the biggest detractor to the Fund in the period. The biggest driver of this change is the ongoing evolution of investor perception of China, and the uncertainty around its zero-COVID policy which is curbing domestic consumption. High energy prices are an additional tax for consumers and companies in South Asia and has weighed on equity returns particularly in the second quarter. In addition, small caps have continuously underperformed this year reflecting concerns around rising cost of capital and weak domestic demand in many parts of Asia but this follows past few years of outsized returns.

Foreign exchange trends have remained consistent through the first half reflecting some depreciation for Southeast Asia currencies and the Indian rupee. However, there was a sharp change in the trend for the Chinese renminbi which depreciated by about 3% late in April—in spite of that move, the renminbi trades at roughly the same level compared to three years ago.

Performance Contributors and Detractors:

For the first half of 2022, stock selections in Thailand, the Philippines and Indonesia contributed the most to the Fund’s relative performance. Southeast Asian countries have shown late but sustained economic recovery from the pandemic. On the other hand, stock selection within Taiwan and South Korea detracted the most from relative performance. There has been a general technology sector correction amid a growth-to-value style rotation in Taiwan and global macro concerns over the interest rate hiking cycle have negatively affected South Korea. It is notable that underperformance within China was more concentrated in the first quarter. Some of that relative underperformance was recovered during the second quarter, given the emergence of supporting policies from the Chinese government. Thus, during the second quarter, the Fund’s holdings such as China Tourism Group, a China-based company principally engaged in the travel agency and duty-free businesses, and Kweichow Moutai, China’s premier white liquor business, contributed positively. Expectations for travel resumption with China Tourism Group and the resilient operations of Kweichow Moutai with relatively attractive valuations supported the performance of these companies. On the other hand, continuous concern over the macro environment further dragged down South Korea holdings in the second quarter. For example, industrial holdings such as Doosan Bobcat, a South-Korean construction machinery manufacturer, underperformed amid worries over upcoming headwinds though current earnings have been resilient.

From a sector perspective, real estate and consumer staples were positive contributors during the first half, helped by our holdings in shopping mall companies in the Philippines and Thailand with improved foot traffic, and Kweichow Moutai in China as its push towards direct sales progressed well. Meanwhile, financials, information technology (IT) and communication services detracted from the fund’s performance in the first half. The Fund’s holdings in South Korea’s communication services sector, such as Naver, a search engine and internet content provider, and Hybe, an artist management company, underperformed with potentially weakening demand and increased cost burdens combined with relatively high valuations to begin with.

Notable Portfolio Changes:

We increased the portfolio’s weight in China by adding to existing holdings such as China Tourism Group and Meituan, a web-based shopping platform company, as valuations became more attractive while long-term earnings generation capability remains intact. We believe these companies are likely to benefit from a recovery in domestic consumption. This was funded by trimming positions in the IT sector in South Korea and Taiwan. Though these IT companies have strong fundamentals, near-term earnings uncertainty risk has increased as these companies are exposed to the global demand environment.

We also exited positions with demanding valuations and deteriorating earnings visibility. This is a part of efforts to manage the downside risk and reallocate capital into areas where we see better earnings visibility with certain valuation supports. SEA, an internet gaming and e-commerce company in Singapore, is an example. While the company has achieved an impressive track record in establishing sizable market share across different countries, increased uncertainty around its internet gaming as a “cash cow” may delay the expected profitability goal amid continuous needs for e-commerce investment.

Although the portfolio’s number of holdings has decreased to a near-term low, especially in China, it is quite likely that the position count may increase into the second half of 2022 as we look to benefit from cheaper valuations.

Outlook:

Looking ahead, the Asia ex Japan region is in a relatively better situation from a macroeconomic standpoint as the inflationary pressures are not as severe as in the West, and several countries are still in the process of recovering fully from COVID-19 related disruptions. In particular, China is positioned well for a pickup in domestic activity as the government is starting to support consumers and small and medium-sized 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 the region, shopping mall operators like in Southeast Asia, stand to benefit from resumption of tourism activities.

The earnings picture looks a bit mixed largely because of downgrades earlier in the year in China as several key cities were locked down but that is changing for the better. Valuations have eased to a low-teens P/E ratio while the projected earnings growth (average) over the next two years for the MSCI Asia ex Japan Index is in the high single digits. We are sanguine about the potential economic recovery in parts of Asia and are looking to position the portfolio to participate in that growth.