Period ended June 30, 2019
For the first half of 2019, the Matthews Asia Dividend Fund returned 5.82% (Investor Class), while its benchmark, the MSCI All Country Asia Pacific Index, returned 10.71% over the same period. For the quarter ending June 30, the Fund returned -1.16% (Investor Class), while the benchmark returned 0.90%.
After a strong rally in the first quarter of 2019, Asian equities were unable to sustain the positive momentum during the second quarter. A sudden collapse in U.S.–China trade negotiations weighed heavily on the market. Together with the renewed concerns over the strength of the global economy, market volatility spiked. It wasn't until June when central banks globally stepped in to signal a readiness to support growth via monetary easing that Asia's markets began to stabilize again.
Performance Contributors and Detractors:
The Fund's underperformance year to date has disappointed. Our investment process, which involves a barbell-approach to investing in both higher-yielding dividend-paying stocks together with faster-growing dividend growth stocks, remains unchanged. However, poor stock selection drove the bulk of the Fund's relative underperformance for the first half of the year. Consumer staples holdings were among the performance detractors. Known for their defensive business models with strong cash flow generation and steady dividend payments, these stocks traditionally have been positive return contributors. But as some of these businesses have begun facing certain structural changes—whether via market disruption brought by new product technologies, changing consumer preference or rising labor cost pressures from demographic changes and government policy intervention—the resilience of those businesses has somewhat eroded. As a result, their share prices languished during the period. This painful investment experience has led us to recognize the need to better emphasize identifying structural trends earlier on, to better foresee the investment implications and take more decisive action.
On the flip side, among the top performance contributors during the first half was our holding in Chongqing Brewery, a regional beer company listed in the onshore China A-share market. Our initial investment thesis of seeking a sustained profit margin improvement supported by an accelerating beer product "premiumization" trend in China and easing competition intensity whereby major beer brands are prioritizing profit improvement over market share gain, started to play out this year. In addition, the pending public listing of Budweiser's Asia-Pacific beer business further attracted investor attention in the region's beer industry. As a result, Chongqing Brewery, a well-run operation under the ownership of Carlsberg, is seeing positive share price movement.
Notable Portfolio Changes:
During the second quarter, we initiated a few new positions, one of which was Yunnan Hongxiang Yixintang Pharmaceutical Group, a drugstore chain in mainland China. One of China's key health care reforms involves separating drug dispensing functions from Chinese hospitals, which should boost the prescription drug business at drug retailers and bring additional customer traffic for higher-margin, non-prescription drug businesses. At the same time, rising pharmacy quality-control standards and stricter tax compliance for running drugstore businesses also favor large-scale players over small, individual-store operators. This could further speed up the overall drugstore industry consolidation—a long-term growth driver for leading players such as Yixintang. We believe the company is well-positioned to take advantage of this favorable industry trend. Operating a cash-generative drug retailing business model, with a modest 30% payout ratio, the company also has what we view as untapped potential to deliver significant growth in its dividends. During the first half of the year, we exited a few existing holdings such as China Resources Power, Japan Tobacco, and Nitori Holdings as their business fundamentals no longer supported our initial investment thesis.
As China and the U.S. restarted trade negotiations in early July, Asia's markets seemed to experience temporary relief from tensions. The medium- to long-term outlook for these bilateral relations, however, is still cloudy given the structural differences between the two countries' political systems and economic growth models. Despite this uncertainty, policymakers in both Asia and the U.S. have signaled a willingness to use policy-support measures to address any significant slowdown. In the meantime, with investor expectations now reset mostly due to macroeconomic concerns and on Asia's equity valuations continuing to trade below long-term averages, we remain constructive that, from a bottom-up perspective, Asia's markets currently offer attractive opportunities for long-term investors.
As of 6/30/2019, the securities mentioned comprised the Matthews Asia Dividend Fund in the following percentages: Chongqing Brewery Co., Ltd. 2.3%; Yixintang Pharmaceutical Group Co., Ltd. 1.1%. The Fund held no positions in Seven & i Holdings Co., Ltd. or ABInbev (parent company of Budweiser); Carlsberg Group; China Resources Power Holdings Co., Ltd.; Japan Tobacco, Inc.; Nitori Holdings Co., Ltd. Current and future portfolio holdings are subject to risk.