Matthews Japan Fund


Period ended 31 March 2018

For the quarter ending 31 March 2018, the Matthews Japan Fund returned 3.38%, outperforming its benchmark, the MSCI Japan Index, which returned 0.98%.

Market Environment:

Japan's equity markets ended the quarter near the same level at which they started the year on a dollar basis as a January rally gave way to a correction in February and March. Though equity prices declined on a local currency basis, the roughly 6% gain by the yen versus the U.S. dollar offset those declines. The Trump administration's moves to levy tariffs on steel and aluminum imports and on imports from China prompted fears of an escalating trade war, dampening investor sentiment in global equity markets. At the same time, Prime Minister Shinzo Abe and his wife confronted allegations of cronyism in connection to a discounted sale of state-owned land to a private school. This resulted in a sharp decline in his approval ratings.
 
Meanwhile, Japan's economic growth is starting to show sluggishness. Annualized real GDP growth during the last quarter of 2017 was 1.6%, but those figures were supported by inventory buildup, which could result in issues over the coming quarters. Business investments and private consumption remain solid but we believe a contraction in net government expenditures will lead to slower growth in 2018.

Performance Contributors and Detractors:

The Fund outperformed its benchmark during the quarter, driven by stock selection primarily within our mid- and small-cap holdings. Among the mid-caps, Nihon M&A Center, which facilitates mergers and acquisitions among small- and medium-size enterprises (SMEs) in Japan, was a top performer on the back of robust revenue growth as demand for its services continues to expand.  

The top contributor by sector to relative performance was information technology. Semiconductor production equipment manufacturer Lasertec rallied on the back of healthy order inflows for equipment to be used in advanced lithography processes at a major logic foundry customer. Cloud software service company Infomart also performed well as its growing online billing platform enters the monetization phase.
 
On the negative side, our holdings in the consumer discretionary sector were the largest detractor to relative performance. 100 yen shop operator Seria performed poorly as sales and profits fell short of expectations. Shares of fashion e-commerce company Start Today also declined as its long-awaited smart body suit that promises a “guaranteed fit” has been plagued by production delays. 

Notable Portfolio Changes:

During the quarter, we initiated a position in Otsuka, a distributor of IT products targeting SMEs in Japan. SMEs have been particularly affected by labor shortages and are aiming to improve productivity by adopting more IT into their operations. We expect Otsuka to be a major beneficiary as it aims to cross-sell its various products. We also initiated a position in Shimadzu, Japan 's leading producer of analytical and measuring equipment. Shimadzu is one of the global “big four” in the analytical and measuring equipment market along with U.S. companies such as Agilent, Waters and Thermo Fisher Scientific. Shimadzu boasts a leading position in China 's measuring equipment market where demand is accelerating for R&D and environmental monitoring purposes.

To fund these positions, we exited our holdings in Oracle Japan and optical components company Hoya. Oracle Japan rallied last year on the back of solid growth for its cloud services but valuations had become stretched. We deemed Otsuka to be a more attractive way to invest in the growing IT sector. We expect Hoya to face an increasingly challenging environment for its glass media products used in hard disc drives.  

Outlook:

We remain cautious about the outlook for Japanese equities. We believe profit growth for listed companies will slow in the fiscal year starting April 2018 due to tougher comparables, a stronger Japanese yen and higher fuel costs. Though Japanese equity valuation levels remain reasonable, we see little room for multiple expansion in light of the lack of near-term growth prospects. Additionally, we are concerned by the Trump administration's combative actions regarding trade. Japanese corporate activity remains sensitive to global trade. Prime Minister Abe 's declining approval ratings are also a concern for political continuity as he is seeking re-election as the leader of the ruling Liberal Democratic party in September. 

The bright spot for Japanese companies lies elsewhere within Asia, particularly among opportunities in China. China is investing heavily in upgrading its manufacturing sector as it seeks to drive technology innovation. Rising wages also are leading to increased spending on consumer products. We firmly believe that sustained growth in Asia will lead to tremendous growth opportunities for select Japanese companies and we will continue to focus our research efforts on identifying such companies.  

Rolling 12 Month Returns for the period ended 31 December 2017
Matthews Japan Fund 2017 2016 2015 2014 2013
I (Acc) (USD) 33.40% 0.19% n.a. n.a. n.a.
MSCI Japan Index (USD) 24.39% 2.73% n.a. n.a. n.a.
I (Acc) (GBP) 21.57% 20.43% n.a. n.a. n.a.
MSCI Japan Index (GBP) 13.62% 22.53% n.a. n.a. n.a.

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. These and other risks associated with investing in the Fund can be found in the Prospectus.



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