Matthews China Small Companies Fund


Period ended 30 September 2020

For the quarter ending 30 September 2020, the Matthews China Small Companies Fund returned 1.32%, while its benchmark, the MSCI China Small Cap Index, returned 10.79% over the same period.

Market Environment:

Chinese monthly economic data continues to show signs of recovery as reflected in the latest manufacturing and service PMI data as well business recovery statistics. Domestic recovery is occurring alongside a stabilizing export sector and improving labor market, both of which should support better earnings prospects going forward.

COVID-19 remains a risk for economies globally, including China. While small pockets of coronavirus infections still occasionally emerge, China remains successful at flattening its curve of COVID-19 infections. Vigilant about testing, quarantining known cases and contact tracing, China has had the most success among large economies in our view in combatting the virus.

Small- and mid-cap equities in China—companies with market capitalization between US$1 billion and $10 billion—generated attractive stock price gains calendar year to date. Much of these gains occurred within the information technology, health care and the consumer staples sectors. At the same time, the strong stock price performance of these sectors has largely been driven by expansions in price-to-earnings multiples, resulting in higher valuations.

Performance Contributors and Detractors:

Flat Glass, which manufactures solar glass that goes into the solar panel module, was a notable contributor. China is very close to achieving grid parity, where the price of renewable energy becomes more competitive with the price of energy produced through fossil fuels. The trajectory of renewable energy expansion in China is very clear in our view and we expect continued solar growth in China given the government's supportive policies, such as a goal of carbon neutrality by 2060. We believe Flat Glass is well-positioned within the competitive landscape of China's solar industry, where scale matters and there are only a few key players in the space.

On the other hand, a detractor in the quarter was Times China, which focuses on developments in the Greater Bay Area in Guangdong province. China's policymakers have earmarked the region for further development in high-value-adding sectors such as the technology and financial industries, and is likely to see growth in infrastructure connectivity over time. Times China has an ample land bank in this region, allowing it to continue to grow its footprint. The real estate industry has been sluggish as the pandemic has disrupted sales in China, but we continue to like the company's long-term prospects in land banking, as well as its attractive valuations.

From a sector perspective, stock selection and an overweight in health care detracted from relative returns in the quarter. Health care names generally saw a pull back over the quarter, and investors became more valuation conscious and took profit off names that did very well in the earlier half of the year. Many biotech related names also saw a correction given less of a risk appetite. Turning to sectors that were contributors, stock selection in industrials contributed to relative performance. 

Notable Portfolio Changes:

Given the strong run-up in the market earlier in the calendar year, we trimmed or exited some holdings in the quarter where valuations had significantly increased since the start of year. For example, we took profits in sectors such as information technology, health care and consumer staples, reallocating the proceeds into other areas where valuations look more attractive. In areas where we've trimmed back, such as the information technology, health care and consumer staples sectors, we expect to re-invest and maintain meaningful exposure of these sectors over time.

Many of our closed positions in the quarter were in the biotech industry, reflecting rising valuations, as well as the difficulty of assessing which product pipelines may yield game-changing new drugs and treatments. Biotech holdings we exited in the quarter include Genscript Biotech Corp., Cansino Biologics and Burning Rock Biotech. With a keen interest in the health care sector, we rotated the capital into other health care area that we believe have more visible earnings growth profiles. New positions in the quarter include independent clinical laboratory service provider Dian Diagnostics Group.

Dian Diagnostics is an independent clinical laboratory services provider that has just gone through an expansion phase. The company's heavy investment period has just come to an end, and in the next few years, the company will begin to ramp up the operations of its new laboratories, and will likely see an expanding margin profile as utilization increases. We remain convinced that outsourced clinical laboratory services will be a secular trend as hospitals become more budget and efficiency conscious and look to outsource services to scaled providers such as Dian, who are able to perform required services at lower fees.

Outlook:

Schools have reopened in Wuhan, the first city to be hit by the pandemic earlier in the year. China's effective health care response has played an important role in reopening school, businesses and government offices across China. Keeping the coronavirus under control is key to maintaining China's economic recovery, and the portfolio team continues to see reasons for optimism on the public health front. Positive sentiment among domestic Chinese consumers is spurring increased economic activity. Fiscal stimulus in China has been incremental in scope and highly targeted, a trend the portfolio team expects may continue. Interest rates in China have moved higher, reflecting China's economic resilience amid the pandemic. Positive sentiment among domestic Chinese consumers is spurring increased economic activity.

Chinese manufacturing data points to a continued V-shaped recovery and a bright spot within the data suggests that small, private businesses are beginning to participate within the rebound. Even the slow-to-recover consumer-oriented sectors are starting to show improvement including restaurant sales, cinema box office receipts and domestic travel. Domestic recovery is occurring alongside a stabilizing export sector and improving labor market, both of which should support better earnings prospects going forward. 


Rolling 12 Month Returns for the period ended 30 September 2020
Matthews China Small Companies Fund 2020 2019 2018 2017 2016
I (Acc) (USD) 69.95% 6.04% 0.73% 30.59% 17.85%
MSCI China Small Cap Index (USD) 16.67% -11.71% -8.05% 17.14% 8.85%

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 currency, 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. Investments in a single-country fund may be subject to a higher degree of market risk than diversified funds because of concentration in a specific country. The Fund invests in smaller companies, which are more volatile and less liquid than larger companies. These and other risks associated with investing in the Fund can be found in the Prospectus.



Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than larger companies.

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