For the first half of 2021, the Matthews Emerging Markets Equity Fund returned 9.33% (Investor Class) and 9.32% (Institutional Class), while its benchmark, the MSCI Emerging Markets Index, returned 7.58% over the same period. For the quarter ending June 30, the Fund returned 7.69% (Investor Class) and 7.68% (Institutional Class), while the benchmark returned 5.12%.

Market Environment:

The second quarter of 2021 saw a high degree of dispersion below what appeared to be a calm quarter. Chinese equities were essentially flat in the second quarter and underperformed global emerging markets (“EM”). Sectors also displayed a high degree of return dispersion. Many of the larger Chinese internet companies, in particular, had a hard quarter as regulatory pressure continues to weigh on sentiment. The drag created by these large platform companies also led to smaller capitalization companies outperforming their larger peers.

The market remains dominated by a few key questions. One large debate relates to the structural vs. transitory nature of inflation in several economies, including the U.S. The easing of supply constraints should dissipate inflationary pressure for quite a few categories; however, expectations have also probably risen and at the Federal Open Market Committee meeting in June, the Fed had a more hawkish tone than that of March. Notably, the median projection of the Fed Funds Rate is for two hikes by the end of 2023. Gradual increases in U.S. rates are, on balance, not bad for EM and could indeed be positive if they are in part predicated upon strong economic activity coming out of the pandemic. Certain EM economies may see positive terms of trade impacts, should the positive price evolution in certain commodities like energy and base metals continue.

The other big question is where the world stands related to COVID-19. There’s been significant progress among many developed economies in terms of vaccine rollouts, which has been counterbalanced a bit by new coronavirus variants emerging and ongoing health care challenges in countries such as India. Continued uncertainty has muted enthusiasm, but many countries where the virus remains problematic are also experiencing high levels of investor interest.

Contributors and Detractors:

For the first half of the year, our overweight to Vietnam (which is not represented in the benchmark) was a contributor to relative performance from a regional perspective. On the other hand, stock selection in Taiwan was a detractor. From a sector perspective, stock selection in energy and health care contributed to relative performance, while stock selection in financials was a detractor.

Turning to individual securities, our two positions in Vietnam, FPT Corp. and Military Commercial Joint Stock Bank, were among the largest contributors during the first half of the year. Vietnam has a large current account surplus, positive real GDP growth, a growing population and relatively benign inflation. Our attraction to Vietnam has to be backed up by company-level fundamentals, however. FPT Corp. is among the largest technology companies in the country, and is a top 10 holding. It is both a leader in providing broadband internet as well as in information technology (“IT”) services to companies abroad, mainly in the U.S. and Japan. Military Commercial Bank is a leading joint-stock bank in the country and has among the larger exposures to Vietnamese consumers within the financial system. Vietnam is the only frontier market the portfolio is currently invested in.

On the other hand, New Oriental Education & Technology Group was a detractor. The company is among the older, larger and more established education companies in China. We bought the company partly on the expectation of a positive evolution in enrollment with the re-starting of in-person learning post pandemic. Ultimately, we sold out of the company as regulatory clouds persist in the education space which may limit the timing and types of services that private education companies can offer in China.

Notable Portfolio Changes:

We had a quite active second quarter, adding seven new unique positions and exiting nine. New positions in the quarter include Chinese A-share company Beijing Oriental Yuhong, a leader in waterproofing coatings. We believe the company’s market is set to grow as construction spend shifts to quality. In contrast to many of the tech companies that are suffering from regulatory headwinds, we think better construction durability is aligned with China’s development objectives. In contrast, we sold Anhui Conch Cement Co., a leading and profitable Chinese cement company, during the quarter after seeing little to be excited about in terms of earnings evolution. We also initiated a position in Fix Price Group, a Russia-based chain of discount companies, comparable to a “dollar store” in the U.S. It sells mostly low-priced merchandise, rotating most of its items to generate consumer excitement while being one of the most reliable value stores for basic consumers. We believe the business model of Fix Price will allow the company to expand rapidly in the regions it operates as well as within existing stores via densification. In our view, the company is in the rare position of being able to grow fast and pay a sizable dividend at the same time. With a net-cash balance sheet, high management ownership and solid returns on capital, the company fits our strategy’s philosophy.

Outlook:

In its own words, the Fed is “talking about talking about tapering.” As previously mentioned, higher rates that accrue gradually due to increased economic activity could be viewed as net positive for emerging market assets. We believe valuations on a relative basis are attractive in EM, as all asset classes are fairly picked over after years of very accommodative monetary policy. We’ve seen select EM currencies—notably the Brazilian real—strengthen over the quarter, which may continue over the second half of the year.

While there’s been significant progress in vaccine rollouts among many developed economies, it has been counterbalanced a bit by new variants of the virus emerging. That said, firms and countries have adapted to the challenges of operating during a pandemic, and we’re quite optimistic that reopening and the next normal will be a durable trend in the second half of 2021. The scope and nature of durable change at the company level as a result of pandemic is something we are highly focused on.

With a benchmark-agnostic approach, the portfolio is broadly diversified by country and sector, based on bottom-up stock selection. China is our largest underweight relative to its position in the MSCI Emerging Markets Index. The regulatory topography in internet/internet-adjacent, education and healthcare sectors, in particular, is hard to decipher, and this keeps us on the sidelines. More clarity on the regulatory environment in these sectors would be a welcomed development. However, there are still many great companies with durable advantage and the country remains our largest overall allocation in an absolute sense. As previously mentioned, relative to the benchmark one of our largest overweight markets is Vietnam. We believe it is quite possible that Vietnam will be upgraded from frontier to EM status by one or more of the relevant indices in the next few years. Our positions in Vietnam are by and large driven by the positive evolution of the domestic economy there. We have three positions in Mexico, but each is partly predicated upon the recovery of the global economy as much as the domestic conditions of Mexico. We highlight this contrast explicitly because it is in keeping with our “company then country” approach. We do not allocate to countries top down.

We continue to seek out high-growth, high-quality companies across emerging markets and across the market capitalization spectrum, looking for companies that can adapt and thrive across a broad range of conditions.

As of June 30, 2021, the securities mentioned comprised the Matthews Emerging Markets Equity Fund in the following percentages: FPT Corp., 2.6%; Military Commercial Joint Stock Bank, 1.6%, Beijing Oriental Yuhong Waterproof Technology Co., 1.1%; and Fix Price Group, Ltd., 1.2%. The Fund held no positions in Anhui Conch Cement Co. and New Oriental Education & Technology Group.

Current and future holdings are subject to change and risk.

Average Annual Total Returns - MEGMX as of 06/30/2021