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Signs of Life for Dividend Growth

Matthews Asia Portfolio Manager Yu Zhang provides an update on the Fund.

The first half of 2021 was positive for Asian equities. A semi-synchronized global economic recovery gained momentum throughout this period and led to a market rotation from growth to value-orientated companies in the first quarter of 2021.

Last quarter, however, proved to be a story of two very distinct phases. A slowdown in Chinese growth, a COVID-related market sell-off and a shift in inflation expectations proved detrimental for the more interest-rate sensitive, cyclical value names in Asia. Toward the end of the second quarter, markets rotated back toward growth stocks. In times like these, a flexible approach that can balance exposure to quality growth and more cyclically sensitive stocks can help investors navigate markets driven by different styles.

The Matthews Asia ex Japan Dividend Fund offers such an approach. It blends dividend-growth stocks and dividend payers depending on market conditions, offering investors participation in both growth and value markets. The Fund ended 2020 with an approximately 60/40 weighting in favor of dividend growth. By the end of the first quarter this split reduced to approximately 50/50, whereas in the second quarter, the overall balance moved back to favor dividend growers as we took advantage of the volatility to add growth names that were indiscriminately sold off during the correction.

Fund performance reflected the potential benefits of a flexible approach: For the first half of 2021, the Matthews Asia ex Japan Dividend Fund returned 9.48%, while its benchmark, the MSCI All Country Asia ex-Japan Index, returned 6.51% over the same period. For the quarter ending 30 June, the Fund returned 8.11%, while the benchmark returned 3.66%.

China and Vietnam

The largest contributors to relative performance during the quarter came from holdings in China and Vietnam. While Chinese equities did not perform well over this period, dragged down by a combination of macroeconomic concerns and increased regulatory oversight, stock selection and a large underweight mitigated much of these losses.

At the same time, some sectors rose above the overall lacklustre broader market performance due to fundamental drivers. One such sector is industrials where we see opportunities in industrial automation solutions providers and manufacturing equipment companies for electric vehicles or lithium battery products.

While we are still waiting to see a meaningful recovery from the Chinese consumer, we believe that Chinese consumer stocks can potentially offer some opportunity if inflation starts to peak in the latter part of the year. For now, the portfolio has taken a light positioning on consumer businesses, given their multiple expansion in 2020. In addition, consumer sentiment was hit by inflation and bouts of COVID resurgence across Asia, and that’s one reason why many consumer names have been struggling year to date.

Meanwhile, we more than doubled our exposure to Vietnam by taking advantage of COVID-related sell-offs to add to existing holdings and introduce new names during the second quarter. Having begun 2021 with a 3% weighting, by the end of the second quarter close to 7% of the Fund was invested in Vietnamese securities. Despite the recent setback from the COVID pandemic, the structural growth story offered by the Vietnamese economy and many of its listed companies still attracts investors, and Vietnamese shares rallied year to date after significant underperformance in 2020.

In our view the increase in outsourcing of manufacturing activity from China is likely to benefit companies in Vietnam more than any other country in Asia. Furthermore the Vietnamese government continues to pursue a market friendly reform agenda. While valuations have largely caught up with the MSCI Asia ex Japan Index, they still look reasonable in our view. 

Small- and mid-caps march on

Rather than country or sector allocation, the biggest driver of the Fund’s relative return continues to be stock selection. This is particularly true for the Fund’s small-cap exposure where small caps have contributed over half of the performance in the second quarter, a story which is also repeated year-to-date.

In Asia, small-cap businesses offer an interesting overlap between delivering growth and returning this growth in the form of rising dividends. Often these can be fast growing businesses where the original founder/family is still the majority shareholder. For them, dividends are a significant source of income and cash flow, and therefore are more likely to be resilient in their dividend policy and may emerge quicker from a coronavirus lockdown. In addition, at the early stages of a cyclical rebound of both the economy and corporate earnings, small caps tend to bounce more owing to their larger operating leverage.

The Fund’s small and mid-cap exposure rose from about 39% at the end of 2020 to 59% at the end of June 2021, and we believe they are well-positioned for medium- and long-term corporate earnings growth. Some of the small-cap holdings, more for industry or company-specific reasons, posted strong positive earnings growth, and that has generated attractive performance over the second quarter. 

Portfolio positioning for inflation

Inflation has been a much-debated topic throughout this year. After a rather disruptive rotation in the first half, equity markets have more or less re-adjusted to the new environment, pricing in rising inflation expectations and a potential tapering of loose monetary policy.

Having increased the portfolio’s exposure to financials during the first quarter of the year on the basis they would benefit from a rising interest rate environment, this weighting decreased towards the end of the second quarter. We also slightly cut back the portfolio’s cyclical holdings, including energy and materials, as we watch out for a potential peak in GDP numbers and normalization of monetary policy. 

Outlook

Despite the challenges of the last 18 months, the dividend growth story in Asia remains steadfast. Overall, we expect a meaningful rebound in both corporate earnings and dividend payments, but that is mainly due to the low base of 2020 when companies suffered widespread pandemic-related disruptions. Whether earnings growth can be sustained longer term is a different question. In our view, Asian equities are fairly priced at the moment. They are neither cheap, nor expensive at this point. So where do we see opportunities?

Heading into the second half of 2021 and beyond, cyclical businesses are likely to lead the early earnings recovery phase in our view, while structural growth drivers such as domestic consumption and industrial upgrades could return to drive further earnings growth, particularly in China. The broadening of the economic recovery beyond China continues to be another potential source of ideas for the portfolio.  

As fundamental, bottom-up investors, we pay close attention to whether risks have been priced in correctly and valuations are attractive.  In our view, Asia equities today provide intriguing opportunities for active investors. 


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Risk Considerations

The value of an investment in the Fund can go down as well as up and possible loss of principal is a risk of investing. Investments in international and emerging market securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. The Fund invests in holdings denominated in foreign currencies, and is exposed to the risk that the value of the foreign currency will increase or decrease. The Fund invests primarily in equity securities, which may result in increased volatility. There is no guarantee that the Fund or the companies in its portfolio will pay or continue to pay dividends. These and other risks associated with investing in the Fund can be found in the Prospectus.

All performance quoted represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate with market conditions so that when redeemed, shares may be worth more or less than the original cost. Current performance may be lower or higher than performance shown. Investors investing in Funds denominated in non-local currency should be aware of the risk of currency exchange fluctuations that may cause a loss of principal. Performance details provided are based on a NAV-to-NAV basis with any dividends reinvested, and are net of management fees and other expenses.

For Institutional/Professional Investor Use Only

The Fund is a sub-fund of Matthews Asia Funds SICAV, an umbrella fund, with segregated liability between sub-funds, established as an open-ended investment company with variable capital and incorporated with limited liability under the laws of Luxembourg. Investment involves risk. Past performance is no guarantee of future results. The value of an investment in the Fund can go down as well as up.

This document is not a Prospectus/Offering Document and does not constitute an offer to the public. No public offering or advertising of investment services or securities is intended to have taken effect through the provision of these materials. This is not intended for distribution or use in any jurisdiction in which such distribution, publication, issue or use is not lawful. Investors should not invest in a Fund solely based on the information in this document.

An investment in Matthews Asia Funds may be subject to risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. The current prospectus, Key Investor Information Document or other offering documents (“Offering Documents”) contain this and other information and can be obtained by visiting global.matthewsasia.com. Please read the Offering Documents carefully before investing as they explain the risks associated with investing in international and emerging markets. It is the responsibility of any persons wishing to subscribe for shares to inform themselves of and to observe all applicable laws and regulations of any relevant jurisdictions. Prospective investors should inform themselves as to the legal requirements and tax consequences within the countries of their citizenship, residence, domicile and place of business with respect to the acquisition, holding or disposal of shares, and any foreign exchange restrictions that may be relevant thereto. An investment in the Matthews Asia Funds is not available in all jurisdictions. The Fund’s shares may not be sold to citizens or residents of the United States or in any other state, country or jurisdiction where it would be unlawful to offer, solicit an offer for, or sell the shares. No securities commission or regulatory authority has in any way passed upon the merits of an investment in the Fund or the accuracy or adequacy of this information or the material contained herein or otherwise.

The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.

 

IMPORTANT INFORMATION

The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.