Matthews China Dividend Fund


Period ended 31 December 2018

For the year ending 31 December 2018, the Matthews China Dividend Fund returned -10.44% while its benchmark, the MSCI China Index, fell -18.75%. For the fourth quarter, the Fund returned -6.90% versus -10.73% for the Index.
 

Market Environment:

2018 was a year of turbulence for Chinese equities. Protracted U.S.—China trade tensions and rising U.S. interest rates became two significant overhangs for Chinese markets. In addition, China's financial de-leveraging campaign, which is designed to rein in excessive shadow-banking activities and to reduce systemic risk, nevertheless caused a near-term economic slowdown. A further worsening of sentiment stemmed from policy flip-flops that left investors casting doubts on some industries, such as education services and pharmaceuticals, which have long been perceived as benefiting from China's secular growth potential. Facing such external and internal headwinds, Chinese equity markets across domestic A-shares, listings in Hong Kong and U.S. American Depositary Receipts all suffered steep, double-digit losses. 

Performance Contributors and Detractors:

Given the fragile market sentiment in 2018, those of our holdings that were in a good position to ensure earnings growth, generate healthy cash flow and maintain resilient balance sheets performed well during the downturn. Not surprisingly, the Fund's top three performance contributors for the year, CITIC Telecom International Holdings, HKBN and China Gas Holdings, all shared these characteristics. 

On the contrary, companies with shorter track records of being publicly listed, as well as those that faced uncertain regulatory environments, performed badly. Hope Education Group, the Fund's top performance detractor, unfortunately fell into this category as it completed its IPO during the year. Its management team fell short in delivering on an acquisition that it had planned to complete before the IPO. This failure, combined with an uncertain regulatory environment for China's private education industry, led to its shares being sold off aggressively. We are closely monitoring the situation.

On a sector basis, stock selection in the newly created communication services sector contributed most to relative performance. Shares of telecom operators CITIC Telecom International and HKBN outperformed those of internet service companies in the sector. In 2018, our stock selection in the energy sector posed a drag as two small-cap energy companies underperformed their larger peers. Our small-cap holdings overall for the year, however, generated significantly more relative positive performance than our larger-cap holdings. This highlighted that a total return approach can be beneficial in selecting attractive investment opportunities even when small-cap companies face a challenging market environment. 

Notable Portfolio Changes:

During the fourth quarter, we switched out one Chinese property management company for another. We exited A-Living Services and initiated a position in China Overseas Property Holdings. As valuations for the two companies neared the same level, we felt compelled to swap holdings in favor of the company that we believe has more organic growth potential.
 
In addition, we exited a few positions, including Sporton International and China Aviation Oil, as their total return potential no longer met our criteria.
 

Outlook:

Near-term market volatility is likely to remain elevated as investors grapple with a decelerating Chinese economy and a possible slowdown in U.S. GDP growth. Ironically, such reversals in growth trajectories might pave the way for removing two large external overhangs for Chinese equities—a full-blown trade war between China and the U.S. and U.S. dollar strength driven by monetary tightening. A dimmer growth outlook in China and the U.S. could add both incentive and a sense of urgency for the two nations to reach a deal. While the struggle between China and the U.S. goes well beyond just trade issues, a compromise that averts an all-out trade war could still significantly reduce market uncertainty. Similarly, if the U.S. dollar starts to weaken on the back of less hawkish U.S. Federal Reserve policy, emerging markets, led by China, could also start to recover. Chinese policymakers have already prioritized the stabilization of the country's economic growth with both fiscal policy support and more accommodating monetary conditions. A combination of the above policy outcome, together with a Chinese equity valuation that is already well below its long-term average after the 2018 sell-off, could set the stage for an equity market recovery.

Rolling 12 Month Returns for the period ended 31 December 2018
Matthews China Dividend Fund 2018 2017 2016 2015 2014
I (Acc) (USD) -10.44% 38.09% 6.09% 7.94% 0.92%
MSCI China Index (USD) -18.75% 54.33% 1.11% -7.62% 8.26%

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. There is no guarantee that the Fund or the companies in its portfolio will pay or continue to pay dividends. 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. These and other risks associated with investing in the Fund can be found in the Prospectus.



There is no guarantee that a company will pay or continue to increase dividends. 

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