Matthews China Small Companies Fund


Period ended 30 June 2020

For the first half of 2020, the Matthews China Small Companies Fund returned 52.25%, while its benchmark, the MSCI China Small Cap Index, returned -1.75% over the same period. For the quarter ending 30 June 2020, the Fund returned 37.99%, while the benchmark returned 13.18%.

Market Environment:

During the first half of the year, the COVID-19 pandemic continued to cause significant disruption to businesses around the world. The deep drops suffered across risk assets during the first quarter were almost entirely reversed over the last three months with central bank and government intervention. Governments around the world continue to provide monetary and fiscal support. 

Pre-COVID-19, China was on track for a strong earnings recovery 2020 after a first phase trade deal was signed in January by the U.S. and China. Business spending, which was muted for three years due to the U.S.–China trade conflict, was set to rebound and domestic consumption continued to be strong. The recovery in 2020 was briefly disrupted by COVID-19. Given China's quick response to quarantining the epicenter city of Wuhan and other high-infection rate cities, businesses in China have largely resumed work. The government has also put into place targeted stimulus towards elevating small to medium business cash flow disruptions with easier access to loans and reduced tax burdens. Overall, we expect gradual recovery in business activity in China for the rest of the year despite localized second and third wave infections. 

From both a top-down and bottom-up perspective, we anticipate long-term sustainable growth in the Chinese economy and in corporate earnings. Market concerns over trade disruption should, in our view, have little impact on China's smaller companies, given their domestic focus and lower dependence on financial leverage.

Performance Contributors and Detractors:

Our focus on finding innovative and capital-efficient small companies that are relatively insulated from macroeconomic uncertainties served us well during the first half of the year. Strong stock selection in the information technology, health care and consumer staples sectors contributed the most to the Fund's outperformance versus the benchmark. 

Top contributors to Fund performance were our two largest positions in the portfolio, Silergy Corp. and Kingdee International. Silergy is a top analog semiconductor company from China. Its main power management integrated circuit products are going through an accelerated structural growth phase with more complex power management needs in data centers, 5G network equipment and laptops for working remotely. Kingdee, China's top enterprise resource software-as-a-service (SaaS) company, helps firms managing their businesses digitally. The COVID-19 pandemic has quickened the pace of connecting the real world to the digital economy, and we expect Kingdee to benefit longer term from this structural trend. 

There were no sector level detractors on performance during the first half. Among individual securities, Burning Rock Biotech, a new position in the portfolio, detracted slightly from performance. Burning Rock is a front runner in the precision diagnostics space in China. The company uses next generation sequencing technology to facilitate cancer diagnosis and for determining course of treatment through identification of cancer biomarkers such as Tumor Mutation Burden (TMB). We believe the company has a long runway of growth in this growing space.

Notable Portfolio Changes:

During the quarter, we also initiated positions in Peijia Medical and Hongfa Technology. Peijia completed its initial public offering during the second quarter. Peijia's products help patients with stroke management to avoid open heart surgery. Hongfa is a top power relay company in China with reasonable valuations and a broad exposure to electric vehicles, power grid investments and automation.

During the quarter we exited our positions in Cstone Pharmaceutical and TK Group as we identified better risk-reward candidates from our watch list. Cstone Pharmaceutical has an impressive pipeline of clinical stage oncology assets but it may be too much for a young biotech company to manage. TK Group continues to be a respectable plastic mold and parts producer in China but its end exposures in consumer electronics, automotive and household appliances may be a negative drag for longer than expected due to COVID-19. 

Outlook:

We remain optimistic about China's small-cap market amid heightened market volatility as we continue to focus rigorously on the sound fundamentals of our portfolio companies. From a macroeconomic perspective, we believe China can stabilize its economy through monetary flexibility, fiscal spending, tax reform, interest-rate adjustments and currency management. In addition, we believe that steps to correct China's structural issues are on the right track. We will continue to seek companies with sustainable, quality earnings streams, strong cash flows and good balance sheets that can weather uncertain economic conditions. We believe sectors such as industrial automation, consumer, health care and technology are among the most attractive from a secular growth perspective.

 

Rolling 12 Month Returns for the period ended 30 June 2020
Matthews China Small Companies Fund 2020 2019 2018 2017 2016
I (Acc) (USD) 71.81% -12.43% 36.36% 29.36% -16.45%
MSCI China Small Cap Index (USD) -2.99% -13.89% 15.64% 14.49% -27.94%

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