For the quarter ending September 30, 2017, the Matthews China Fund (Trades, Portfolio) returned 11.83% (Investor Class) while its benchmark, the MSCI China Index, returned 14.76%.
Market Environment:
China’s economy continued on firm footing in the third quarter of 2017. GDP growth is expected to remain stable, and at a similar rate to the 6.9% growth in the first and second quarters of 2017. The third quarter included robust job creation, particularly in the services industry, and healthy trends in wage growth. As a result, consumption trends and consumer confidence have remained resilient. Infrastructure spending also continued during the third quarter on projects such as new subway lines and environmental cleanup. In our view, the government’s supply-side reforms in the commodity sectors have been largely successful this year. We continue to see fewer capacity additions to industries such as steel and coal that have experienced overcapacity issues. This resulted in higher prices for commodities and lifted profitability for historically troubled areas of the economy and has broadly helped to improve profits at Chinese firms.
Performance Contributors and Detractors:
During the quarter, information technology, materials and real estate were among the best-performing sectors for the Fund. Top contributors to absolute performance included one of China’s largest cement companies, China National Materials (Sinoma). The firm’s outperformance relative to the benchmark is, we believe, an example of China’s resolve in executing supply-side reforms and encouraging more streamlined operations at state-owned enterprises through mergers and acquisitions. Among other top contributors to Fund performance was ZTE, China’s second-largest telecom equipment company. ZTE has, in our view, demonstrated strong technological readiness for future 5G deployments and has continued to gain market share globally.
China Life, China’s largest life insurance company, was a main detractor to Fund performance. Slower-than-peer growth and continued investments into non-core businesses were among the primary market concerns related to this stock. We continue to believe, however, that valuations for the company remain reasonable and that the longer-term outlook for life insurance products remains robust.
Notable Portfolio Changes:
In the third quarter, we turned relatively more positive on health care stocks and added to Sino Biopharm (HKSE:01177, Financial). Earlier in the year, the health care sector had struggled with concerns over increased regulations and drug pricing pressures. We believe that these are necessary steps, however, toward a leaner and more robust health care system in China that would help to propel innovation and affordable drugs.
Over the period, we also added RYB Education (RYB, Financial), a preschool and kindergarten education company, to the portfolio. Early childhood education in China is growing rapidly as parents have identified a lack of quality preschool options in the education system. Further, more affluent Chinese parents today are increasingly willing to spend on their children’s education.
Elsewhere in the portfolio, we consolidated some of our smaller domestic A-share positions due to valuation concerns. A-shares account for approximately 10% of total Fund holdings but we continue to identify what we believe are good businesses and look to expand our A-share holdings over time.
Outlook:
Given China's steady growth so far this year, we remain cautiously optimistic heading into the fourth quarter. We believe that robust consumption spending, strong infrastructure spending and strict supply-side reform have created a favorable economic environment for businesses. As a result, corporate profits and cash flows have significantly improved in the recent quarters. We expect the accommodating business climate will continue in the foreseeable future. In the second half of October, China will hold its 19th National Party Congress. President Xi Jinping is expected to be confirmed for his second five-year term, and a new line of leaders will be elected under him. We expect China's political environment will remain stable going forward. In managing the portfolio, we will continue to seek companies that can, in our view, deliver sustainable earnings growth at reasonable valuations.
As of 9/30/2017, the securities mentioned comprised the Matthews China Fund (Trades, Portfolio) in the following percentages: China National Materials Co., Ltd. 2.8%; ZTE Corp. 1.9%; China Life Insurance Co., Ltd. 6.3%; Sino Biopharmaceutical, Ltd. 1.1%; and RYB Education, Inc. 0.5%. Current and future portfolio holdings are subject to risk.
The views and opinions in this commentary were as of the report date, subject to change and may not reflect 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.
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. Neither the funds nor the Investment Advisor accept any liability for losses either direct or consequential caused by the use of this information.
