Matthews Asia Perspectives
Matthews Asian Growth and Income Strategy: 25 Years of Building and Protecting Wealth
September 6, 2019
The Matthews Asian Growth and Income Strategy launched in 1994. Over 25 years, Asia's equity markets have generated attractive long-term returns, peppered with bouts of volatility. Designed to capture Asia's dynamic growth potential, the Strategy seeks to offer a lower volatility approach to investing across the region. In this Q&A, Lead Portfolio Managers Robert J. Horrocks, PhD, and Kenneth Lowe, CFA, discuss the Strategy's heritage and approach. Robert J. Horrocks also serves as Chief Investment Officer for Matthews Asia.
How has the Strategy remained true to its investment process?
Kenneth Lowe: The Matthews Asian Growth and Income Strategy has always attempted to generate attractive absolute risk-adjusted returns through a full market cycle, with a keen eye on risk mitigation. We believe preserving capital in challenging times is an intrinsic part of generating long-term wealth for our clients.
Multiple elements of compounding are associated with our approach. First, by protecting on the downside and delivering lower volatility, we seek to create a steadier total return profile for the Strategy over time. Second, income generated by securities in the portfolio also compounds over time and can provide a significant amount of an investor's total return. Third, we believe our focus on quality companies that generate high returns on capital should be able to generate sustainable and compounding growth.
For investors who are interested in capturing Asia's growth potential, but who also may worry about the region's volatility, the Strategy has provided a way to stay invested. Time in the market—rather than timing the market—is especially important in Asia, where cycles are often shorter and can change direction quickly.
What was the genesis of the Strategy?
Robert J. Horrocks: Our founder, Paul Matthews, understood that investors need to stay invested across market cycles in order to participate in Asia's growth. With Asia equities, investors tend to get drawn in at the top of the market and then scared out at the bottom. Accordingly, Paul identified several ways to dampen volatility using the public markets.
The basic toolkit for building a portfolio includes higher-yielding equities, dividend growth equities and convertible bonds. The income stream these types of securities produce has the potential to smooth out bumps in the road. What's more, if we own quality businesses, pay attention to valuation and avoid overpaying for those businesses, that approach can also generate downside protection. Notably, convertible bonds offer a floor during down markets, while still offering upside potential.
With a lower volatility approach, there's the possibility that investors may give up a little bit of upside in the short term during bull markets. However, there's also better potential to protect capital during bear markets and compound at an attractive rate for the long term. For investors concerned about volatility, the Strategy has provided a time-tested approach to capturing growth.
What quality metrics do you look for in companies?
Kenneth Lowe: Quality is an important piece of downside protection, as well as long-term value creation. Accordingly, we look at quality from many angles. These include:
- The strength of a company's business model. We are attracted to companies with wide economic moats created through advantages such as network effects, switching costs, cost advantages and the creation of intangibles through things like brands.
- The skill and experience of a company's management team. We look for companies with a proven track record of value creation, as well as consistency between commitment and actions.
- How a company allocates its capital. We prefer companies with attractive dividend payout ratios, and those that focus on striking the right balance between reinvestment, dividends and buybacks.
- The appropriateness of a company's capital structure relative to its business model. We look for companies that can strike the right balance between financial leverage and operating leverage.
- How a company governs itself. We favor companies with incentive structures and interests that are aligned with minority shareholders, transparency and discipline, independence and correct board structures.
Where do you find growth in Asia?
Kenneth Lowe: As always, we continue to look for growth opportunities primarily on a bottom-up basis. The scale, dynamism and diversity of the consumer base that is apparent in the region as household income levels rise is favorable for long-term investors. The diversity of the consumer base is creating opportunities for companies in multiple industries across Asia.
In areas of basic consumption such as appliances and dairy, we still see room for growth, particularly in parts of China and other emerging markets. Leading companies with solid market shares can use those to penetrate further into smaller cities as well as enter adjacent categories to drive growth. Within higher end consumption, some global luxury goods and spirits companies expect a significant portion of their future growth to come from Asia and continue to invest heavily in the geographies we cover.
Outside of the direct consumer sectors, domestic and international travel continues to be a structural trend. As travel picks up, companies such as airports are monetizing the retail space within their terminals, turning some of these well-managed operations into profit centers. And the build out of social safety nets continues apace. We see plenty of growth likely to come from areas such as life insurance as demographics, urbanization and rising incomes drive citizens toward protecting their lifestyles and health.
Whether it is in direct consumer spending, physical infrastructure, social infrastructure, or the deepening of financial markets there are still plenty of domestically oriented growth drivers.
How do you balance growth and income in the portfolio?
Kenneth Lowe: We are generally agnostic about whether a company is a “growth” company or an “income” company. Ideally, we would own businesses that are high quality, have robust levels of sustainable growth and are priced at attractive valuations, including a reasonable dividend yield. Unfortunately, most investors also seek those characteristics!
This means that a sense of balance is required and leads the portfolio to own businesses that may fall into either category. More income-oriented holdings in areas such as real estate investment trusts and utilities typically provide less-volatile returns for the portfolio and help with capital preservation. The portfolio's convertible bond holdings also do this as they provide a floor in down markets, as well as provide potential upside capture as they can be converted to the underlying equities when share prices move up. These potential upside/downside skews can be very attractive. Within growth equities, we seek to buy quality companies with the potential to compound their growth if they are sensibly priced. But within this area, the visibility and sustainability of growth is far more important to us than short-term earnings per share growth.
In most market environments, this leads the portfolio to businesses that, on average, may grow around 5% to 15% annually and provide a dividend yield of around 2% to 4% as we balance both growth and income.
What lies ahead for the next 25 years?
Robert J. Horrocks: I believe the Strategy remains relevant for investors. For as long as Asia continues to save and invest more than the West, it will continue to outgrow the West. Over the long term, that means faster profit growth, too. Asia's commitment to investing in research and development, to “better quality growth,” should increase the purchasing power of its consumers and support better returns to shareholders. In many parts of Asia, the services economy is still in the very early stages. Household incomes are rising and consumer spending power is growing. And companies are competing on elements such as customer service and intellectual property to help differentiate their brands. These are all exciting growth opportunities—therein lies the opportunity, but oftentimes the risk, too.
Kenneth Lowe: As Robert says, there are plenty of interesting growth opportunities. Part of our approach is to avoid areas that are short-term fads or business models where we don't see a path to profitability. Our aim is to stay emotionally disciplined and invest in companies that can generate attractive risk-adjusted returns across a full market cycle. We want to make sure that our portfolio companies have visible and sustainable earnings and income streams. For long-term investors seeking to capture a larger share of global growth, we believe an allocation to Asia through an actively managed, lower volatility approach can be a sound strategy for building and protecting wealth.
Robert J. Horrocks, PhD
Chief Investment Officer
Kenneth Lowe, CFA
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.