For the first half of 2016, the Matthews Pacific Tiger Fund (Trades, Portfolio) returned 4.04% (Investor Class) while its benchmark, the MSCI All Country Asia ex Japan Index, returned 2.32%. For the quarter ending June 30, the Fund returned 3.82% (Investor Class) while its benchmark returned 0.51%.
Market Environment:
Since the start of the year, capital markets in Asia have battled concerns ranging from capital outflows from China and the impact of a rising U.S. dollar on Asian economies, to the more recent political developments in the U.K. and Europe. Following a rocky start, a partial recovery in Asian equities was led by large-cap stocks primarily in countries like Taiwan and South Korea. However, the potential negative impact from Brexit on global trade and financing flows may continue to weigh on the Asian region in the near term.
In spite of the variety of challenges during the first six months of the year Asia markets finished the period modestly higher, although that masks a wide divergence between country specific indices. Cyclical stocks bounced in a reflex rally toward the end of the first quarter, but then weakened again in the second quarter. Domestic mainland markets in China experienced the sharpest declines, while Thailand was one of the better performers.
Performance Contributors and Detractors:
Divergences across Asia markets continued in the second quarter, with well-capitalized, well-run businesses outperforming during the period. Consequently, stock selection was a key contributor to performance in the second quarter as reflected in our allocation to good, quality companies, including Central Pattana (BKK:CPN, Financial), a well-capitalized mall operator in Thailand and the best performer during the quarter. Central Pattana continues to deliver strong performance on the back of its solid business model. Genting (XKLS:3182, Financial), a gaming company in Malaysia, outperformed in the first quarter, although that reversed somewhat in the second quarter as earnings were soft given weakness in the gaming environment. Baidu (BIDU, Financial), the leading search engine in China, was the largest detractor from performance in the second quarter, as it came under regulatory scrutiny due to issues in their health care business. Cleanup of this part of this business has affected near-term earnings, hence weakness in their stock price. Baidu has been in this predicament before but has shown they can clean up and improve their systems and sales processes. We expect a similar outcome in due course of time.
By country, India and South Korea were positive contributors to performance in the second quarter, largely reflecting a technical rebound following weakness seen in the first quarter.
Notable Portfolio Changes:
We continue to take advantage of volatility in markets by rotating capital away from our investments where valuations have become expensive to businesses that are more reasonably priced. In aggregate, this has resulted in shifting some of our allocation away from South Korea into China. In addition, we have deployed capital in India following weakness in specific stocks which we have been following.
Outlook:
For a change, the Asian region, more specifically, the Chinese economy is not driving the rise in global economic uncertainty. While the next steps and the fallout from Britain’s decision to leave the European Union remain uncertain, the outlook for domestic demand in Asia is much more easily understood. For the past two to three years, consumption has supported domestic demand, while investment activity has been grinding lower across many parts of Asia. However, it is also worth noting that in countries like Thailand and Malaysia, household debt has continued to expand in the past few years, and the tepid outlook for income growth suggests consumption growth may not be as supportive as in the recent past. Yet there are other countries such as India, Indonesia, and the Philippines where the outlook for income growth and household debt is not overly constraining to continued growth in private consumption.
That being said, policymakers and central bankers realize the need to boost investment growth, which has led to vigorous rate cuts in economies like Indonesia and hopes for greater fiscal support in other countries like India. The purest driver of investment activity is, however, continued emphasis on structural reforms to boost productivity and ease the cost of doing business in any given country. In this regard, progress has been slow and uneven, whether it is reform for state-owned enterprises (SOE) in China or easing land and labor regulations in India and Indonesia. Nonetheless, these are issues that are well defined and are being gradually addressed. We believe there is an opportunity for Asian businesses and policymakers to clearly set themselves apart from the uncertainty that might impact economic activity globally.
The views and opinions in this commentary were current as of June 30, 2016. 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.
Statements of fact are from sources considered reliable, but neither the Funds nor the Investment Advisor makes any representation or guarantee as to their completeness or accuracy.
As of 06/30/2016, the securities mentioned comprised the Matthews Pacific Tiger Fund (Trades, Portfolio) in the following percentages: Central Pattana Public Co., Ltd. 3.2%, Genting BHD 1.5% and Baidu, Inc. 2.7%. Current and future portfolio holdings are subject to risk.
