Period ended 30 September 2020
For the quarter ending 30 September 2020, the Matthews Asia Total Return Bond Fund returned 3.85% (I Acc) and 3.95% (I Dist), while its benchmark, the 50% Markit iBoxx Asia Local Bond Index (ALBI) / 50% JP Morgan Asia Credit Index (JACI), returned 2.19% and Markit iBoxx Asian Local Bond Index returned 2.26%.
Markets have remained relentlessly optimistic in the quarter even in the face of recessionary economic data and poor COVID-19 outcomes throughout much of the world. It was unusual for risk-on assets, like U.S. growth stocks, as well as safe-haven assets, like 10-year U.S. Treasuries, to achieve all-time highs in the same month of August. Within Asian credit, high yield outperformed investment grade as investors felt more comfortable taking more risk for more yield. Asian currencies, on average, were stronger versus the U.S. dollar. It was looking like the Roaring Twenties (2020s that is), even as a second wave of COVID cases hit the U.S. and later, Europe.
September was a risk-off month as markets focused more on the potential bad news—an uncertain result on U.S. Election Day, impasse over a second stimulus package, growing second-waves in Europe forcing more shut-downs and a more delayed timeline for a COVID vaccine. The best performers of August became the worst performers in September. The dollar rose, especially versus emerging market (EM) currencies, whose countries face growing COVID cases and lack the economic resilience and toolkit to combat them.
Within Asian credit, volatility continues to plague companies with the highest credit risks, especially ones with high leverage and upcoming refinancing needs. The markets need to see a clear path to refinancing for these companies before pricing them higher. On the other hand, investment grade and relatively higher quality high yield companies, such as Chinese property companies, have mostly recovered and many breached new highs in the third quarter.
Performance Contributors and Detractors:
The primary drivers of performance during the third quarter were the U.S. dollar-denominated (USD) holdings in the portfolio. Within USD high yield, the biggest contributors to returns were China issuers, including two China property developers: Dalian Wanda and China Franshion. The convertible bonds of Bosideng, a leading down apparel manufacturer in China, also rose largely on the improving fundamentals in China.
The biggest detractors to performance this quarter came from the bonds of Indonesian garment manufacturer PB International, Philippines-based fast food chain Jollibee's, as well as Thai government bonds. PB International's bonds fell when Moody's downgraded the company based on its upcoming financing needs and increased working capital needs from an elongated working capital cycle. Jollibee's bond prices fell as revenues continue to remain tepid given the slow pace of reopening and consumer spend in its markets. The price of Thai government bonds fell as yields rose in the quarter.
During the quarter currency was a slightly positive contributor to performance, with gains in Chinese renminbi overweight partially offset losses due to Indonesian rupiah and the Indian rupee underweight.
Notable Portfolio Changes:
In the third quarter, we exited our positions Chinese internet companies JD.com and Baozun, as these had recovered from the crisis and had reached our price targets. We deployed the funds to add Chinese property developer Times China and the convertible bonds of Poseidon Finance, a financing entity under China Shipbuilding Investment Corporation, a state-owned Chinese shipbuilder exchangeable into Postal Savings Bank of China. We initiated these positions based on their attractive relative value and their strong fundamentals.
On the local currency side, we added China Cinda's renminbi-denominated bonds to increase our exposure to China currency and rates. We also added local currency-denominated bonds of the Philippines and Malaysia on the expectation that their currencies and rates have room to outperform those of other riskier Asia markets.
We expect the fourth quarter to be an event-driven quarter. Driving volatility will be the U.S. election, debates over a new stimulus package, the relative success of countries' response to the pandemic and potential breakthroughs in COVID-19 testing/vaccines/treatment. We recognize that the global economic recovery is still fragile and could worsen if global COVID cases rise or fiscal stimulus lapses. We have already seen geo-political risks resurfacing, in particular between U.S. and China. Despite the Phase One trade agreement having been signed in January 2020, we believe the risk of rising U.S. – China political tensions remains.
On the other hand, we also see potential upside for the market, especially for Asia credit if any of the events listed above turns out positively. In the face of this uncertainty, our strategy will be bar-belled, looking to add both high-quality, relatively low risk credit duration and companies that have been disproportionately hurt by the pandemic or recessionary fears with room to rally if risk sentiment turns positive. Over the medium to long term, we still believe that Asia USD high yield bonds offer the most attractive risk-adjusted returns and we will continue to allocate to this space when we find opportunities.
With the market continuing to reassess the pace of economic recovery, the U.S. 10-year interest rate is on net 3 basis points (0.03%) higher for the quarter. In Asia, we expect to see relatively muted movements in interest rates for most countries. After having reduced interest rates in most Asia countries, we believe some Asia central banks are taking a wait and see approach to additional interest rate cuts.
For currencies, the dispersion of performance going forward will be higher. While a general recovery in risk sentiment helps all Asian currencies, we are mindful of differences between countries, including both country specific macro fundamentals and where each country is relative to the virus cycle.
As of September 30, 2020, the securities mentioned comprised the Matthews Asia Total Return Bonds Fund in the following percentages: Bosideng International Holdings, Ltd., Cnv., 1.000%, 12/17/2024, 4.0%; Wanda Properties International Co., Ltd., 7.250%, 01/29/2024, 4.9%; Poseidon Finance 1, Ltd., Cnv., 0.000%, 02/01/2025, 3.1%; Franshion Brilliant, Ltd., 5.750%, 07/17/2067, 3.0%; Times China Holdings, Ltd., 6.200%, 03/22/2026, 2.6%; Poseidon Finance 1, Ltd., Cnv., 0.000%, 02/01/2025, 3.1%; Thailand Government Bond, 1.600%, 12/17/2029, 2.2%; China Cinda Asset Management Co., Ltd., 5.500%, 03/14/2028, 1.5%; Jollibee Worldwide Pte, Ltd., 3.900%, 07/23/2068, 1.4%. The Fund held no positions in JD.com, Inc.; Baozun. Current and future portfolio holdings are subject to change and risk.