Matthews Asia Credit Opportunities Fund


Period ended 30 June 2020

For the first half of 2020, the Matthews Asia Credit Opportunities Fund returned -5.75% while its benchmark, the J.P. Morgan Asia Credit Index, returned 2.26%. For the quarter ending June 30, 2020, the Fund returned 8.94% compared to the benchmark return of 6.08% over the same period.

Market Discussion:

We have now witnessed the end of a credit cycle in Asia after an unusually long run of 11 years. The old adage in credit analysis that “cash is king but liquidity rules” is important in this part of the cycle as credit markets begin their recovery. Differentials in access to liquidity across companies, industries, countries and regions are dictating the recovery for issuers.
 
For the most credit-worthy issuers, liquidity is ample. In fact, issuance in U.S. investment grade hit all-time highs in the first half. Asian investment grade issuance has also recovered reasonably well in recent months. The combination of central bank buying and investors' demand for safety means that recovery in the investment grade market has been broad, having a positive spillover to Asia bonds through relative value. Asian investment-grade credit spreads narrowed 40 basis points (0.40%) in the second quarter, after rising by 123 basis points (1.23%) in the first quarter.

For high yield issuers, liquidity is more segmented, leading to an uneven recovery. Issuance within Asian high yield is down significantly year-on-year. Issuers from countries like China and in industries like its domestic property sector have been able to borrow in the international capital markets, albeit at a higher cost than earlier in the year. But other countries across emerging and frontier Asia have yet to see meaningful new high yield issuance from their corporates. The biggest uncertainty in the Asian high yield market is whether companies with imminent maturities will be able to refinance their debt. This has led to some parts of the Asian high yield market to be bifurcated between issuers with no refinancing risk, where spreads have tightened substantially, and issuers with refinancing risk, where spreads have tightened much less or even widened since the first quarter. 

Performance Contributors and Detractors:

The primary driver of the Fund's outperformance during the second quarter has been the portfolio's exposure to high yield, which outpaced gains in investment grade issuers. In terms of sectors, exposures in basic industry and consumer discretionary were the top contributors. Within these sectors, issuers such as Indika, an Indonesian coal miner, Tata Steel, an Indian steel producer, and PB International, an Indonesia textile manufacturer, were the top contributors. These names had been among the most punished within the portfolio in the first quarter and therefore, had substantial room to rebound.
  
Amongst the biggest detractors to performance were the perpetual bonds. Within these, China Jinmao and Sino-Ocean perpetual bonds were the top detractors. Perpetual bonds suffered from poor liquidity and wide bid-offer spreads during the crisis and therefore, recovery was much slower in the second quarter due to these liquidity risks. Vietnam Debt and Asset Trading Corporation bonds have been remarkably stable this year and were among the top performers in the crisis, but they were marked marginally lower in the second quarter, leading to a small loss in the position.
 

Notable Portfolio Changes:

We made a number of changes to the portfolio in the second quarter. We exited our positions in sovereign U.S. dollar bonds of the Pakistan and Sri Lanka sovereigns. Given the heavy fiscal burden to be borne by these frontier markets and the limited assistance available from multi-lateral and bilateral institutions, we believe the upside in these bonds were limited. We also exited China's Weibo and Citic Telecom bonds. These bonds carry investment-grade level risk and had performed well during the sell-off. We decided to take profits and redeploy into bonds with a more positive skew. Finally, we exited the bonds of Modernland Realty, an Indonesian property developer because we became less convinced on the company's willingness and ability to refinance its upcoming maturities.
 
We also added a number of bonds in which we saw potential upside in the coming quarters and years. We added Sritex, an Indonesia textile manufacturer, Adaro, an Indonesian energy producer, and Syngenta, a chemicals company based in Switzerland wholly owned by ChemChina, a state owned enterprise. These bonds had a slower pace of recovery since the first quarter sell-offs, but we felt that their fundamentals warrant further recovery.
 

Outlook:

Many Asian high yield companies are asset-rich and have little solvency risk. In fact, in terms of economic fundamentals, Asia in many ways actually looks better than the U.S. The economic reopening in Asia is further along than that in the U.S., giving companies in Asia a better environment to operate in. For instance, for China real estate developers, which represent the biggest overweight in the portfolio, many are seeing sales match or surpass levels from a year ago and they've seem to be experiencing a V-shaped recovery. As such, we expect Asia high yield default rates to be lower than that of U.S. and global high yields. However, companies typically do not default because of solvency, but because of lack of liquidity. As such, we see liquidity as both a near-term challenge and a long-term opportunity. Our top priority is a careful evaluation of each company's capital structure, liquidity profile and refinancing channel to help us navigate the recovery and uncover opportunities.

For long-term investors, we believe it is currently an attractive entry opportunity because yields are elevated due to continued financing risk. As the new issue market normalizes in the coming quarters, we believe the liquidity premium in Asia high yield will continue to go down, driving bond price appreciation. 


Rolling 12 Month Returns for the period ended 30 September 2020
Matthews Asia Credit Opportunities Fund 2020 2019 2018 2017 2016
I (Dist) (USD) -0.98% 10.39% -2.21% 5.88% 14.25%
J.P. Morgan Asia Credit Index (USD) 5.63% 10.80% -1.01% 2.17% 10.55%
I (Dist) (GBP) -4.98% 16.91% 0.39% 2.52% 33.78%
J.P. Morgan Asia Credit Index (GBP) 0.69% 17.25% 1.85% -1.08% 28.91%

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. Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. The Fund may invest in the following: derivatives which can be volatile and affect Fund performance; high yield bonds (junk bonds) which can subject the Fund to substantial risk of loss; and structured investments which can change the risk or return, or replicate the risk or return of an underlying asset. The Fund invests in holdings denominated in foreign currencies, and is exposed to the risk that the value of the foreign currency will increase or decrease. 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 Distribution 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