Matthews Pacific Tiger Fund commentary for the fourth quarter 2014.
For the year ending December 31, 2014, the Matthews Pacific Tiger Fund returned 11.79% (Investor Class), outperforming its benchmark, the MSCI All Country Asia ex Japan Index, which returned 5.11%. For the fourth quarter of the year, performance fell by -1.19% (Investor Class) versus a 0.17% increase by the Index.
Matthews Pacific Tiger Fund: Market Environment
The health of the Chinese economy, expectations around rising rates in the U.S., and the prospects of structural reforms in India and Indonesia were the key factors affecting the capital markets in Asia. The Chinese government continues to focus on improving the allocation of capital within the economy and slowing investment growth while, at the same time, enhancing the quality of growth. In the short run, that has translated into weaker economic activity as both investment- and export-related growth suffered in 2014. The asymmetric interest rate reductions in November, which saw the lending rate fall more than the deposit rate, and the partial opening up of the Shanghai Stock Exchange (SSE) to overseas investors, catalyzed a strong recovery, boosting the SSE Composite Index to be a top performer, globally in 2014.
The interest rates in the U.S. did not eventually rise as some analysts expected; although the prospect of an increase was enough of a wake-up call for countries like India and Indonesia to take corrective action by holding interest rates steady even in the face of falling inflation. These countries reduced energy subsidies, while embarking on structural reforms that have the potential of improving productivity within their economies.
Throughout the year, the MSCI Asia ex Japan Index’s gains were muted by widespread currency depreciation in Asia, versus the U.S. dollar. The Malaysian Ringgit was the worst performing currency during 2014, as concerns over high levels of debt and the impact of falling oil prices on tax revenues caused the currency to weaken (Malaysia is one of the few countries in Asia that is an exporter of oil).
Matthews Pacific Tiger Fund: Performance Contributors and Detractors
For the full year, the portfolio’s outperformance was led by holdings in South Korea and India. For example, the Korean beauty products company, Amorepacific’s, continuing traction with consumers in China became much more evident during the course of 2014, as some of their prior marketing initiatives began to translate into market share gains for their skin care products. Meanwhile, in India, the prospect of a recovery in growth led by the government’s reform initiatives was a primary factor behind the recovery in valuation for some of the portfolio’s holdings.
On the flip side, some of the Taiwanese holdings proved to be detractors to relative performance. In Taiwan, the free cash flow yields across several of the holdings have compressed over the past year, and as investors start to anticipate higher rates globally, the constricted yields are less attractive. One of the worst performing stocks for the portfolio was Cheil Worldwide, a Korean advertising agency. Weaker handset sales from Cheil’s major client, Samsung Electronics led to decreased advertising revenues. This, along with a tough economic environment in Europe, offset the company’s progress in China. We are taking advantage of the sell-off by increasing the allocation, as the opportunity to help companies with their branding initiatives in China can become meaningful in a few years’ time.
Matthews Pacific Tiger Fund: Notable Portfolio Changes
We have taken advantage of lower market valuations to acquire new positions in sectors like health care and the consumer sector. One of the newer additions is Yum! Brands, which is continuing to solidify its position as a premier-eating destination for Chinese consumers. The recent setbacks at Yum! Brands around food quality are an opportunity for the management team to establish better controls, and distinguish their offerings from the competition.
Separately, there were some positions that were eliminated from the portfolio, one of them being Megastudy, a provider of education services in South Korea. Although we appreciated management’s efforts to enhance shareholder value, the continuous changes in the regulatory environment eventually had the effect of impairing the company’s business model.
Matthews Pacific Tiger Fund: Outlook
This past year was a test of endurance for several Asian economies, and while some progress was achieved, there is a lot more that needs to be done. The fall in oil prices is a positive, as it lowers inflation expectation and input costs for most of Asia, and may also lead to a more relaxed monetary environment. More importantly, oil price reductions cement Asia’s position as a deeper and broader economic region that is not reliant upon commodity exports for progress. This may translate into favorable capital flows, but there is a risk that this may reduce the impetus to pursue the tough economic reforms that are vital for long-term growth.
The attempts at deregulating supply-side bottlenecks, like land acquisition, are being pursued by the governments in India and Indonesia, although actual progress has been erratic, raising questions over the real impact of these efforts. Meanwhile, in China, the emphasis is on better capital allocation, but the pressure to accelerate investment spending as a way to revive short-term economic growth is building. Ultimately, 2015 is likely to be a test of resolve for policy makers to stay the course on longer term initiatives.
The views and opinions in this commentary were current as of December 31, 2014. 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.
Statements of fact are from sources considered reliable, but neither the Funds nor the Investment Advisor makes any representation or guarantee as to their completeness or accuracy.
As of 12/31/2014, the securities mentioned comprised the Matthews Pacific Tiger Fund in the following percentages: Yum! Brands, Inc., 0.9%, Amorepacific Corp. 3.9%, Cheil Worldwide, Inc.1.3% and Samsung Electronics Co., Ltd. 2.1%. The Fund held no positions in Megastudy Co., Ltd. Current and future portfolio holdings are subject to risk.