Matthews Pacific Tiger Fund


Period ended 31 December 2018

For the year ending 31 December 2018, the Matthews Pacific Tiger Fund returned -10.71% while its benchmark, the MSCI All Country Asia ex Japan Index, returned -14.12%. For the fourth quarter, the Fund returned -2.82% versus -8.60% for the Index.

Market Environment:

Asian markets were volatile throughout 2018. Macro headwinds included the U.S. Federal Reserve's tightening of monetary policy, as well as trade conflicts between the U.S. and China and fluctuating oil prices. In our view, domestic factors, such as China's continued emphasis on slowing credit formation and financial sector concerns in India, played a larger role in generating market uncertainty than trade concerns. Fluctuating oil prices also injected an element of turbulence into markets, with oil prices rising during much of the year before collapsing by year end.

At the start of 2018, we had anticipated the pace of earnings growth to slow, but at the same time for earnings growth to broaden across geographies (beyond China) and sectors (beyond technology and energy). Even as the pace of earnings decelerated in China, there was not a vigorous pickup in economies such as India and Indonesia. From a sectoral standpoint, the recovery in service-oriented sectors such as financials and health care has been negatively affected by regulatory factors.
  
Small and midsize companies continued to struggle throughout 2018—the third-consecutive year that Asian small-cap stocks underperformed their larger-cap peers. This underperformance partly reflected a challenging environment for smaller companies. While many economies in Asia are healthy, growth sentiment has been weak, reflecting some of the macro headwinds mentioned above.

Performance Contributors and Detractors:

The portfolio's overweights in India and Indonesia, and its underweight to the information technology (IT) sector and its lack of exposure to the energy sector, had the completely opposing effects as the year unfolded. During the first three quarters, these allocations were detractors from relative performance, causing the Fund to trail its benchmark. By the fourth quarter, however, these allocations became significant positive contributors to performance, as India's and Indonesia's financial markets held up better than other parts of Asia, and the prices of technology and energy stocks experienced greater declines than other sectors.

Being underweight in the technology sector has been a challenge for the Fund's relative performance in the past, including for the 2017 full-year period. But this underweight helped protect performance during the fourth quarter of 2018. We believe some technology companies came under greater scrutiny by investors as their earnings were likely declining. Within IT hardware, we have long believed the level of profitability of some tech companies is not sufficient to underwrite the volatility in their business models. We continue to invest in the IT sector, but with a discerning eye on valuations, profitability and sustainable growth models.

Detracting from performance for the full year 2018 was our allocation to small and midsize companies. Our small and midsize holdings, however, were positive contributors to relative performance in the fourth quarter, primarily due to stock selection. Over a full market cycle, we expect small and midsize companies to offer more attractive growth potential to larger ones, so we believe that small and midsize stocks should have a meaningful place in a growth-oriented portfolio.

Notable Portfolio Changes:

During the year, we incrementally expanded our exposure to some of the ASEAN (Association of Southeast Asian Nations) economies, including Indonesia. We also added new small-cap companies to the portfolio as valuations were highly attractive following three years of relative underperformance by small caps. A common theme across many of our portfolio additions was exposure to the Asian consumer, whose rising incomes and household wealth remain a key structural driver for Asia's growth.

Companies we exited in the fourth quarter included Guangdong Advertising Group, a Chinese advertising agency that missed some key milestones we had set for the business. We also exited Hengan International Group, a Chinese manufacturer of diapers and personal hygiene products, in order to consolidate our consumer staples exposure in China.

Outlook:

As we look ahead, the nature of the risk facing Asian economies is shifting—away from concerns around U.S. dollar appreciation and balance sheet issues, and toward the outlook for growth and profitability. In that context, some factors that were headwinds for Asian markets in 2018 may be easing. Monetary policy could relax a bit in the region, trade conflicts may ease even if they are unlikely to be fully resolved and oil prices could remain lower through the first half of 2019. We continue to believe in the resiliency of domestically oriented factors that should benefit relatively more from some of the above factors.
 
In China, we find a number of well-run companies trading at attractive valuations. Our emphasis continues to be in the services-related sectors, which cater to the rising aspirations of the consumer and helps corporations gain efficiency in their operations. In India, meanwhile, valuations are still in line or slightly above their historic norms. Earnings are still somewhat depressed in India and anything short of a forceful recovery in growth may test premium multiples. India will also hold elections in 2019, which could impact sentiment either favorably or negatively, depending on the tone and outcome of the campaigns. As we look across the rest of South Asia, we also see opportunities. In Indonesia, domestic households are starting to return to normalcy after suffering multiple shocks in the form of rising interest rates, weakening subsidies and plateauing income levels over the past few years, and may drive consumption growth in coming periods.
 
Instead of worrying about macro headlines, we continue to spend our energy in identifying the businesses most likely to drive Asia's growth in the coming periods. At current valuation levels, investors may not be factoring this growth appropriately. As long-term investors, we look to take advantage of these opportunities. 

Rolling 12 Month Returns for the period ended 31 December 2018
Matthews Pacific Tiger Fund 2018 2017 2016 2015 2014
I (Acc) (USD) -10.71% 39.47% -0.29% -1.91% 11.22%
MSCI All Country Asia ex Japan Index (USD) -14.12% 42.08% 5.76% -8.90% 5.11%
I (Acc) (GBP) -5.71% 27.14% 19.96% 3.14% 18.00%
MSCI All Country Asia ex Japan Index (GBP) -8.78% 29.78% 26.15% -3.63% 11.65%

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. These and other risks associated with investing in the Fund can be found in the Prospectus.



Performance figures discussed in the Fund Manager Commentary above reflect that of the Institutional Accumulation Class Shares and has been calculated in USD. Performance details provided for the Fund are based on a NAV-to-NAV basis, with any dividends reinvested, and are net of management fees and other expenses. Past performance information is not indicative of future performance. Investors may not get back the full amount invested.

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 International Capital Management, LLC (“Matthews Asia”) and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information. 

Information contained herein is sourced from Matthews Asia unless otherwise stated. The views and opinions in this commentary were as of the report date, subject to change and may not reflect the writer’s current views. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Fund’s future investment intent. It should not be assumed that any investment will be profitable or will equal the performance of any securities or any sectors mentioned herein. The information does not constitute a recommendation to buy or sell any securities mentioned.

Investors should not invest in the Fund solely based on the information in this material alone. Please refer to the Prospectus for further details of the risk factors.

Sources: Brown Brothers Harriman (Luxembourg) S.C.A, Matthews Asia, FactSet Research Systems, Bloomberg