Matthews Asia Perspectives
Matthews Pacific Tiger Fund Outlook
13 December 2019
Services Sectors Shine in China; India's Reforms Benefit Entrepreneurs
In this Q&A, Lead Manager Sharat Shroff discusses his outlook for 2020 and trends he is following on the ground in Asia.
Read the article, Matthews Pacific Tiger Fund Outlook
The Matthews Pacific Tiger Fund invests in quality growth companies across the Asia ex Japan region. The Fund's portfolio management team takes a diversified approach that seeks to capture the region's growth across a full market cycle. In this Q&A, Lead Manager Sharat Shroff discusses his outlook for 2020 and trends he is following on the ground in Asia.
China is the largest country weight in the Fund, but the country remains underweight its benchmark, the MSCI All Country Asia ex Japan Index. Where do you see investment opportunities in China? Do you expect to increase the Fund's weight to China?
From a bottom-up perspective, we are excited about services-related companies in China. As incomes rise in China, consumers are spending more in areas such as education, health care, premium foods and beverages and entertainment. We see this as a long-term, secular trend with a long runway for growth. Importantly, businesses in these areas are competing on brand recognition, intellectual property and product quality. Innovation can be quickly rewarded in China's fast-moving marketplaces. In aggregate, the Fund is underweight China relative to its benchmark. When looking at services-related sectors in China, however, we are overweight compared with the benchmark. We have been increasing our exposure to China, but it is also important to remain a diversified approach to investing in Asia ex Japan.
The Fund is overweight India relative to the benchmark. Over the past couple of years, India has faced macroeconomic headwinds. Do you see a turning point in India's economy? Where are you finding compelling opportunities in India today?
Throughout much of 2017 and 2018, Indian policymakers dealt with sticky inflation and persistent current and fiscal account deficits. At the same time, India implemented financial reforms to increase tax collections and create a more level playing field for businesses. These reforms were positive for the long term, but created softer growth in the short term. The good news is that India moved from defense to offense in 2019. The incumbent Bharatiya Janata Party won a resounding victory in this year's election, giving the majority party a clear mandate for action. Policymakers have since lowered interest rates and cut corporate taxes, both of which should be positive for growth.
As always, we invest in individual companies rather than countries. Our overweight to India is the result of bottom-up stock selection. From a company perspective, we like companies in India that can capture consumer spending and benefit from a more level playing field. Notably, the weak macro environment in India enabled some of the better-managed companies to become stronger and magnify their positions of market leadership. We have seen this trend among select financials, where better-run companies can increase their market share, and also in other consumer-related sectors.
The Fund's three-year performance numbers have hit a soft spot relative to the benchmark. How are you addressing this relative underperformance?
When evaluating performance, we believe context is important. The Fund's quality bias means it may underperform the benchmark across some parts of the market cycle. Since inception in 1994, the Fund has outperformed its benchmark over rolling three-year periods 63% of the time. The Fund has also outperformed its benchmark over rolling one-year periods 65% of the time. That said, we are continually reviewing our portfolio to make sure we are capturing our highest-conviction ideas from the bottom up and looking to where future growth is likely to come from.
Have there been any changes to the portfolio team?
We recently expanded our team, with Inbok Song rejoining Matthews Asia as a co-manager of the Fund. Early in her career, Inbok worked as a research engineer for Samsung SDI in Seoul. From 2007 to 2015, she worked at Matthews Asia, including as a portfolio manager. She brings deep investment experience to an already seasoned team of investment professionals, as well as hands-on knowledge of Asia's dynamic technology sector. Inbok also brings relevant experience in portfolio construction and risk management, which can contribute to decision-making around sizing and allocation. Her insights on some of the newer and emerging parts of the Asian economic landscape such as technology will contribute to our idea-generation process. As a co-manager, Inbok is an important contributor to our research and security selection process. We also promoted Raymond Deng from analyst to co-manager earlier in the year, reflecting his contributions to the team, especially in the area of China's services economy.
The technology sector has performed well lately—albeit with considerable volatility. How are you thinking about the sector today?
We divide the sector into two camps—IT services and IT hardware. In our view, the services side of the sector is the more interesting component. Communication services, representing areas such as digital platforms, e-commerce sites, streaming media and social media, have attractive growth potential in our view. In particular, we see South and Southeast Asia as being underpenetrated in digital business models. While China has widespread adoption of mobile payments, the digital ecosystem is still in early days for many parts of Asia.
The IT hardware sector can be quite cyclical. We believe it is prone to short-term cycles, which often are driven by global factors. So we tend to be selective in our holdings in this sector, as across-the-cycle profitability can be fairly uneven. The IT hardware sector attracted investor attention in 2019, as demand for high-end chips as necessitated by the rollout of 5G aided the stock prices of some technology hardware companies in Taiwan.
We realize our underweight in tech hardware (as well as our underweight to Taiwan, home to many tech hardware companies) was a primary detractor from performance over the past three and five years. To address this, we added resources to the team, with Inbok contributing her expertise to our stock-selection process. We are reassessing the opportunity, given current valuations and the ongoing changes to the business model for some of these companies.
Technology was a detractor from performance. What were some contributors?
For the three-year and five-year periods ending November 30, 2019, stock selection in China and stock selection in India both were contributors to relative performance. As mentioned earlier, in China we tend to focus on services-oriented companies and consumer-oriented companies that are likely to benefit from the consumer's desire for a better quality of life. In India, we have focused on companies with the ability to manage their businesses across various economic cycles, and are well-placed to gain market share during tougher times.
What do you see on the horizon in 2020?
China's broader economy has slowed a bit, but we are excited about the quality of China's growth, rather than simply the quantity. Rising incomes and consumption patterns, along with an expansion of the private sector, create more-sustainable growth opportunities. At the same time, U.S.–China trade tensions remain unresolved, and the uncertainty is a drag on corporations' investment plans, particularly in China. The trade tussle created volatility in the market, as well as buying opportunities among quality companies with attractive growth prospects.
Elsewhere, we find a lot to be optimistic about in India's future. The recently lowered corporate taxes and improving liquidity should benefit earnings for better-managed companies. Earnings were revised up and could continue to rise as the effects of India's fiscal and monetary stimulus work their way into consumer's pockets. Risks to India's economy include any potential shocks to oil prices based on geopolitical conflicts, as India imports most of its energy, and prolonged disruption in the financial system.
Looking ahead, we will continue to watch for secular growth trends driven by Asia's consumers. As a result of our bottom-up investment process, our strategy currently tilts toward countries less represented in the benchmark. This is where we see the next generation of quality growth companies emerging within Asia. Take the example of Indonesia. As more people enter the country's middle class, demand for health care is an offshoot of that growth. As incomes rise, people want better health care and a better quality of life. We believe this type of consumer spending is a durable form of growth that can benefit investors with a long-term mindset.
Sharat Shroff, CFA
The MSCI All Country Asia ex Japan Index is a free float-adjusted market capitalization-weighted index of the stock of markets of China, Hong Kong, India, Indonesia, Malaysia, Pakistan, Philippines, Singapore, South Korea, Taiwan and Thailand. It is not possible to invest in an index.
Excess Return is a measure of how much a fund has outperformed or underperformed its benchmark.
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 currencies, 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. These and other risks associated with investing in the Fund can be found in the Prospectus.
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The Fund is a sub-fund of Matthews Asia Funds SICAV, an umbrella fund, with segregated liability between sub-funds, established as an open-ended investment company with variable capital and incorporated with limited liability under the laws of Luxembourg.
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results. 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 Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.