For the quarter ending September 30, 2023, the Matthews Emerging Markets Equity Fund returned -4.74% (Investor Class) and -4.74% (Institutional Class), while its benchmark, the MSCI Emerging Markets Index, returned -2.79%.

Market Environment:

Emerging markets face four key headwinds offset by the tailwind of cheap valuations. A strong U.S. dollar and high real interest rates are generally negative for all international investing. Rising energy prices hurt some firms and help others but on balance they are a challenge for oil importing markets like China and India. Finally, China remains a concern for many investors both qualitatively and quantitatively as sentiment remains weak as do many indicators of economic activity.

There’s reason to believe all of these headwinds are moderating. Central banks—particularly the Federal Reserve—have slowed the speed of interest rate rises and market consensus is for lower rates going into next year. This should also start to weaken the dollar. Some large emerging market central banks have already begun to ease up which has been helpful for their markets. Similarly, the rate of change of energy prices may slow, which allows economies to adjust. While there are signs of recovery in China, the path of the economy remains uncertain as does geopolitics. The last quarter saw accelerating outflows in the emerging markets asset class which naturally weighs on valuation. For example, the MSCI Emerging Markets Index trades at around 13x forward earnings on a 3% dividend yield compared with about 19x forward earnings for the S&P 500, which yields about 1.6%.

Performance Contributors and Detractors:

At the regional level, our underweight and stock selection in China was the biggest detractor to relative performance in the quarter. Our stock section in India was also a big detractor. Conversely, a number of our off-benchmark positions were among the top contributors, including Vietnam and Kazakhstan, while stock selection in Mexico was strong, supported by the country’s gaining prominence as a ‘nearshoring’ destination for trade flows.

At the sector level, stock selection in consumer discretionary was the biggest detractor to relative performance, impacted particularly by market sentiment-driven declines in Chinese ecommerce companies and consumer platforms. Stock selection in financials was also a detractor, again affected by negative sentiment toward China. On the flip side, stock selection in information technology (IT) was the biggest contributor to relative performance. Stock selection in energy also contributed, benefiting from gains in off-benchmark companies with sizable business in emerging markets, like TotalEnergies in France and Woodside Energy Group in Australia.

At the holdings level, Polish retail chain Dino Polska was the worst performer during the quarter. Energy prices often flow through to the production costs of food as well as the distributional expenses and inflation has exceeded pricing rises as of late. We remain very constructive on Dino Polska having visited management earlier this year. TSMC was the largest detractor to total returns in the period as the company experienced adverse sentiment related to global economic growth and cyclical concerns. JD.com, an e-commerce company, and AIA, a Hong Kong-based insurance company, also detracted. JD.com, which is trading at a depressed multiple, doesn’t do anything that is geopolitically sensitive and should benefit from market sentiment stabilizing. Similarly, AIA has reported good growth but has suffered from overall negative sentiment.

Chinese-based Innovent Biologics, the lone biotech company in the portfolio, was the best-performer in the quarter despite volatile sentiment in China and challenges within its sector. FPT Corp., a Vietnamese broadband and IT services company, was the largest contributor to total returns in the quarter. Restaurant Brands Asia, based in India was also a top contributor.

Notable Portfolio Changes:

The Fund only initiated one position during the quarter, in Indian Hotels. The company is among the leaders in the hotel space in India. We believe all segments of travel in India can continue to grow meaningfully over the next decade, and Indian Hotels is well placed in both the luxury and mid-tier segments of the industry.

The Fund exited six positions in the quarter, leaving us more concentrated in names where our confidence levels are higher. TDCX, an IT services company in Singapore, was exited due to other positions exposed to the same theme and our view that the company’s specific service lines are at risk from increased adoption of artificial intelligence. Among the exits we also sold three companies in China, reinvesting proceeds predominantly in other holdings there as well as in BYD, the Chinese market leader in electronic vehicles.

Outlook:

We’re excited about the prospects of our holdings but the equity market itself remains quite weak. Our biggest near-term challenge is the ability of investors to earn 5% by parking money in short-term treasuries as consumer price inflation (CPI) continues to drift down. That won’t last forever. An important part of our analytical framework is consideration of pricing power, and we’re confident most of the portfolio can outpace inflation in prices and earnings in real terms.

Our objective is not to be the best performing fund in a given quarter but rather to be among the better funds over long time horizons. The quality-growth orientation and focus on fundamentals remains a prominent feature of the portfolio which gives us comfort in a market that may continue to be quite volatile. Low prices for well-managed market leaders are an opportunity for the patient hand. Great companies are rare but they are present within emerging markets.

Top 10 holdings as of September 30, 2023. Current and future holdings are subject to change and risk.

Average Annual Total Returns - MEGMX as of 06/30/2024