For the year ending December 31, 2020, the Matthews India Fund returned 16.45% (Investor Class) and 16.65% (Institutional Class), while its benchmark, the S&P Bombay Stock Exchange 100 Index, returned 13.92%. For the fourth quarter, the Fund returned 21.85% (Investor Class) and 21.88% (Institutional Class), while its benchmark returned 24.97%.

Market Environment:

Indian equities suffered large drawdowns early in the year, then rebounded quickly. Markets were down sharply in March amid fears about the pandemic’s economic impact. The government took unprecedented steps to slow the spread of the virus by ordering a nationwide lockdown for 21-days starting on March 25. In addition, the Finance Minister announced significant stimulus early in the year in hopes of aiding low-income households while in lockdown. The Reserve Bank of India took significant steps as well to lower the cost of capital by reducing repurchase agreement (repo) rates and by injecting surplus liquidity to keep the strength of the financial system intact. In the second and third quarters of 2020, Indian shares soared as lockdown restrictions were gradually eased and economic activity started to normalize.

Although its economy has been slow to recover, India’s latest economic data suggests that activity has returned to near pre-pandemic levels. Local sentiment is improving. Economic restrictions in large urban sectors are gradually easing and we are seeing near-normalization of mobility and economic activity. For example, restaurants and bars in Mumbai were allowed to open in early October. Government fiscal accounts are outperforming estimates as tax receipts are coming in higher than expected. In addition, economic output as measured by Purchasing Managers’ Index (PMI) composite data seems well placed in expansionary territory. Rural India has done substantially better in the last 12 months on back of robust rainfall in the last two monsoons, helping to cushion the negative impact of COVID on India as a whole.

Performance Contributors and Detractors:

Stock selection and an overweight to small-cap stocks was a notable contributor to performance in the year. India has a large, rich universe of small companies with low analyst coverage, creating opportunities to generate alpha via active stock selection. What’s more, as economic recovery began to broaden out, smaller companies began to participate more in the market rally. On the other hand, stock selection and allocation effects among mega-cap stocks was neutral to performance in the year. But we continue to see long-term opportunity among select mega-cap companies, particularly as India continues to move toward a more innovation-based economy, where size and scale are often rewarded in terms of digital platforms and connectivity.

From a sector perspective, stock selection in health care, communication services and industrials contributed to performance, while stock selection in financials, consumer staples and consumer discretionary detracted.

Among individual stocks, Laurus Labs was a contributor. Laurus Labs is one of the lowest cost manufacturer of APIs (active pharmaceutical ingredients) used to formulate drugs, particularly in ARV (antiretroviral) drugs. In the last couple of years, Laurus has integrated into manufacturing and marketing their own formulations, which boosted sales and earnings growth substantially. Stock performance has largely followed the earnings growth trajectory. Meanwhile, Shriram City Union Finance, a non-banking financial that is dependent on capital markets and on banks for funding, detracted. Shriram was negatively impacted as liquidity in small and micro-cap companies dried up during March and April. We continue to like this name given management continued to improve their financial performance on back of a notable improvement in credit quality. The company is well capitalized, with enough liquidity on the balance sheet, and it is one of the lowest valuation financial service names in the portfolio.

Notable Portfolio Changes:

We made a few changes to the portfolio across different sectors, including health care, consumer discretionary, financials and IT services.

Within consumer discretionary, we added Bosch India Limited, a supplier of fuel ignition systems to commercial and passenger vehicles in India. Bosch’s business is likely to be positively impacted in our view on back of a cyclical upturn expected in the auto segment in the country. Bosch has been undergoing a restructuring, limiting its margins, but we think it is almost complete and thus believe its revenue growth may lead to substantially higher growth in earnings.

Within consumer discretionary, we recently participated in the IPO of Burger King India. Quick Service Restaurants (QSR) have been gaining share away from small mom-and-pop restaurants over the years and we expect that trend to only accelerate further post pandemic. Burger King India has a very credible management with extensive global experience in the QSR segment that we think will help it grow faster than their peers both on revenue and earnings.

We exited Syngene, a Contract Research Organization (CRO), which we held in the portfolio for over two years. While we believe there is substantial opportunity for growth for many years to come, its stock outperformed sharply during the last 12 months and became excessively overpriced. As we do not think the company’s revenue growth will change substantially, we exited our position as we deemed the risk reward was adverse to continue to remain invested.

Outlook:

Entering into 2021, India’s financial system is seeing signs of reopening with loan growth rebounding and credit quality improving. The stronger current account and overall balance of payments bodes well for the Indian rupee and a potential tailwind for foreign investors. Equity valuations are at or slightly above historical averages; however, we believe that current valuations may not fairly incorporate a lower cost of capital making seemingly high valuations actually much more reasonable. In our view, India is sitting at the cusp of an earnings recovery. The overwhelming majority of companies are delivering earnings in excess of expectations; too many companies to count have taken prudent cost-cutting measures to shore up margins.

India’s central government is taking substantial steps to create more manufacturing jobs in the country. It is offering financial incentives to global corporates for setting up factories in the country, as well as changing its legal framework that governs labor laws in the country to make it much easier to do business in India. Corporates across different sectors are also reporting heightened interest in procuring raw materials and finished products from India as part of an increasing wave of China-plus-India supply chain strategy being considered by corporates globally. We believe the change in external environment combined with steps taken by the government has the potential to create positive surprise on India’s economic growth over the next 24-36 months.

As of 12/31/2020, the securities mentioned comprised the Matthews India Fund in the following percentages: Shriram City Union Finance, Ltd., 2.3%; Laurus Labs, Ltd., 1.4%; Bosch, Ltd., 0.8%; Burger King India, Ltd., 0.8%. The Fund held no position in Syngene International Ltd. Current and future holdings are subject to change and risk. Earnings growth is not indicative of the Fund’s future performance.

Average Annual Total Returns - MINDX as of 12/31/2020