Hidden Gems in Emerging Markets

At Matthews Asia, we believe that small companies in emerging markets are a great way to generate alpha, whatever the market conditions. If we look at the past three years, for example, a combination of the COVID-19 pandemic, regulatory crackdowns in China and a global inflation spike saw many growth companies struggling, which impacted emerging market equity performance. The MSCI Emerging Markets Small Cap Index posted average annual returns of 8.94% versus 1.74% for the MSCI AC Emerging Markets Index in the three-year period ending January 31, 2023. The Matthews Emerging Markets Small Companies Fund outperformed both indices with average annual returns of 16.80% over this period.

Two core tenets drive the Fund’s investment philosophy. The first is that investing in smaller companies is a fundamentally sound way to access the spending power of the fast-growing, large middle class in emerging markets. Large consumer companies, especially multi-nationals, can be good at what they do but they can also be slow in responding to the ever-changing needs of consumers. Smaller, local companies have the potential to be better at identifying— and nimbler to responding to— commercial and consumer trends and creating products and services to address them.

The second tenet is that emerging markets have led in innovation, which we believe will be one of the major economic growth drivers and value creators over the next 30 years. Emerging markets countries have invested heavily in physical infrastructure and in soft infrastructure such as education over the last quarter century. This has helped drive strong economic growth, the creation of a well-educated and increasingly productive workforce and broader, deeper capital markets. As a result, we have seen an explosion of innovative businesses coming to these markets.

“While consumer and innovation stories are exciting, what matters for investor returns is finding the right companies. Discovering the hidden gems has been critical to the Fund’s outperformance.” Vivek Tanneeru, Portfolio Manager

Active Research Uncovers Hidden Gems

We’re focused on finding innovative businesses early in their lifecycle. We track private companies and entrepreneurs before they go public and have a track record of participating in the initial public offerings (IPOs) of smaller companies that have quickly grown into much larger companies. Outside of the U.S., we believe China, and to a lesser extent India, are the only two markets in the world where a small-cap company can double or triple sales in a short space of time and that is why we think emerging markets are an exciting place to invest.

While consumer and innovation stories are exciting, what matters for investor returns is finding the right companies. We aim to identify well-managed, underappreciated companies whose stocks have the potential to “re-rate” once they are noticed by the marketplace. In our view, the key to successful small-cap investing is to research companies thoroughly in order to find the winning combination of a sustainable business model and a quality management team.

Looking beyond the obvious names and discovering hidden gems has been key to the Fund’s outperformance. As an investment team, we conduct over 4,000 meetings a year and out of these we have been able to uncover high-quality companies that are cheaply valued, in our view, and still undiscovered by the market.

Over the past three years, the Fund’s performance has held up well because of our focus on stock selection.  In 2022, four of the 10 largest contributors to performance were growth companies despite the sell-off in the broader growth space. And while we consider China to be a very important market in our universe, our company-first, bottom-up focus has helped us identify companies across emerging markets and mitigate the top-down headwinds China has encountered.

What we have demonstrated over the last three years, and over the longer term, is that this approach to small-cap investing can generate attractive returns that are on a par— or exceed large-caps— while being relatively shielded from regulatory risks, as well as offering diversification benefits. We believe this is one of the many reasons why investors should consider an allocation to emerging markets small caps.

Vivek Tanneeru
Portfolio Manager
Matthews Asia

Learn more about Matthews Emerging Markets Small Companies Fund

Top 10 holdings as of March 31, 2023. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MSMLX as of 03/31/2023

All performance quoted is past performance and is no guarantee of future results. Investment return and principal value will fluctuate with changing market conditions so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the return figures quoted. Returns would have been lower if certain of the Fund's fees and expenses had not been waived. Please see the Fund's most recent month-end performance.

Fees & Expenses

Matthews has contractually agreed to waive fees and reimburse expenses to limit the Total Annual Fund Operating Expenses until April 30, 2023. Please see the Fund’s prospectus for additional details.