Period ended 31 December 2019
For the year ending 31 December 2019, the Matthews Pacific Tiger Fund returned 11.18%, while its benchmark, the MSCI All Country Asia ex Japan Index, returned 18.52%. For the fourth quarter, the Fund returned 7.75% versus 11.85% for the Index.
Asian equity markets generated attractive gains in 2019. The rally was narrow in scope, however, led by a small group of stocks. Information technology and consumer discretionary were the only two sectors to outperform Asia's broader markets. Information technology stocks in particular outperformed the rest of the market by a wide margin. In addition, market gains were concentrated among large and mega-cap stocks. While large and mega-cap stocks have been in favor since 2015, we believe that a deepening macroeconomic recovery might also lead to a favorable economic backdrop for smaller and midsize companies.
Volatility lingered throughout much of the year. Many factors impacting markets over the short term were political in nature, as U.S.—China trade tensions, Hong Kong protests and Indian election results made headlines. By the fourth quarter, however, sentiment throughout the region seemed largely improved on easing trade tensions and a sense of political stability throughout the region. Asian currencies were largely stable in 2019, recovering from earlier weakness in 2018.
From a country perspective, domestic Chinese and Taiwanese markets were top performers, while South Korea's market was relatively weaker. There was a welcome détente in U.S.—China trade tensions toward the end of 2019, although the contours of a trade deal had not yet taken shape. Nonetheless, foreign sentiment toward Chinese shares was notably improved at year end. The portfolio's performance in China in 2019 was led by A-shares and select large-cap consumer discretionary, financials and communication services companies.
Elsewhere, India's equity markets were positive in 2019, but lagged the broader region. Throughout much of 2017 and 2018, Indian policymakers dealt with sticky inflation and persistent current and fiscal account deficits. At the same time, India implemented financial reforms to increase tax collections and create a more-level playing field for businesses. These reforms were positive for the long term, but created softer growth in the short term. The incumbent Bharatiya Janata Party scored a resounding election victory in 2019, giving the majority party a clear mandate for action. India's policymakers gave markets a positive surprise in the second half of 2019 by lowering interest rates and cutting corporate taxes, both of which should be positive for growth.
Performance Contributors and Detractors:
The Strategy's underweight to information technology and Taiwan, home to many of the region's IT hardware companies, was the single-biggest detractor from 2019's relative performance. The IT hardware sector attracted investor attention in 2019 on the back of two drivers. First, there was increased demand for high-end chips as necessitated by the rollout of 5G. Second, trade-related tension between the U.S. and China may increase demand for local sources of semiconductors within Asia. Both of these trends aided semiconductor and IT hardware stocks, principally in Taiwan. We remained cautious about expectations that seemed to be getting priced into many hardware companies across the region. At the same time, we recognized that our underweight in tech hardware detracted from performance. Accordingly, the team re-examined the IT hardware ecosystem in Asia (outside of Japan). We identified a handful of businesses that we believe are able to maintain and grow their profitability across cycles, including a new holding discussed in the next section.
The Strategy's overweight to India also detracted from relative performance in 2019, as did stock selection in India. Stock-selection underperformance in India largely came from a single security, Tata Power. The company faced short-term regulatory setbacks regarding its ownership of mines in Indonesia that created negative sentiment toward the company. We believe the market may have misinterpreted the situation and have faith in the company's long-term prospects. Changes in tariffs, asset monetization by the company and decent growth in the company's renewables portfolio should be fruitful for the company long term. On a positive note, stock selection in the communication services sector was a contributor to relative performance year to date. From a country standpoint, Indonesia, China/Hong Kong and South Korea were contributors to relative performance for the full year.
Notable Portfolio Changes:
During the fourth quarter we initiated a new position in Midea Group, a Chinese company that manufactures, markets and installs household electrical appliances. The company has built a complete portfolio spanning many segments of consumer demand including higher end, innovative products. Midea has an opportunity to continue to grow in China, but also to expand in other parts of South Asia with its affordable value proposition.
We also initiated a position in Taiwan Semiconductor Manufacturing Co. (TSMC), a leading semiconductor foundry company globally. Over the years, TSMC has distanced itself from other global companies in its adoption of advanced manufacturing technology. A key business change that became more noticeable in recent periods was the diversification in its underlying demand, which is much less exposed to single-industry risk, and broad diversification across end clients and segments. We find TSMC an attractive way to gain exposure to this sector.
In addition, we exited Line Corp. (a subsidiary of NAVER), a leading company in the field of mobile applications and internet services in Japan and other parts of Asia. Late in the year, the company decided to enter into an alliance with its primary competitor in Japan, which is likely to lead to a significant improvement in its financials. As such, the stock rerated sharply and we decided to use that capital in other positions in the portfolio.
For many economies in the region, 2019 capped a period of challenges as well as strengths. On one hand, trade-related tensions inhibited private-sector investment, and growth rates across the region continued to moderate as the year unfolded. On the other, policymakers in many parts of Asia made policy choices that painted the macroeconomic backdrop favorably as we look over the short to medium term.
China's broader economy has slowed a bit. The quality of China's growth, however, may be a more interesting factor to watch. Rising incomes and consumption patterns, along with an expansion of the private sector, create more-sustainable growth opportunities. U.S.—China trade tensions have eased, meanwhile, improving foreign investor sentiment. Domestic Chinese investor sentiment already was positive, creating an encouraging near-term backdrop. Over the long term, we expect China's growth to be led by the services sector.
In Southeast Asia and India, which played defense for so long, we see policymakers going on the offense in terms of fiscal and monetary stimulus. Several central banks in the region lowered interest rates and created an adequate liquidity environment that will slowly lower the cost of capital for businesses. Meanwhile, finance ministers, especially in countries like India and Indonesia, are looking to stimulate demand through measures like tax cuts and structural reforms.
Elsewhere, we find a lot to be optimistic about in India's future. The recently lowered corporate taxes and improving liquidity should benefit earnings for better-managed companies. Earnings were revised up in response to lower taxes, but the sustainability will depend on the pickup in investment spending among private-sector companies. Risks to India's economy include potential shocks to oil prices based on geopolitical conflicts, as India imports most of its energy, and prolonged disruption in the financial system.
While these economic measures are being rolled out, expectations among sell-side analysts for long-term growth in Asia are among the lowest in many years. While it may seem counterintuitive at first glance, we find the combination of realistic expectations and favorable valuations to be a constructive environment for equity-market gains because markets have not been overhyped.