The top five holdings of this fund are: Silergy Corp (6415, 6.65% of assets); Kingdee International Software Group Co Ltd (00268, 5.43%); Jiajiayue Group Co Ltd A (603708 , 3.76%); Sichuan Teway Food Group Co Ltd (603317, 3.22%); and KWG Group Holdings Ltd (01813.HK, 3.16%).
Matthews China Small Companies Fund (MCSMX)
From Moneyletter
At first glance, it may seem counterintuitive to be investing in Chinese small cap firms amidst ongoing reverberations of the Covid-19 pandemic and the US-China trade war. After all, China, where the virus originated, seems an unlikely place to invest today and smaller firms might seem to be the riskiest spot to buy. But it appears that many of these smaller firms are better situated to thrive and prosper than many of the nation’s largest companies.
Tiffany Hsiao, lead portfolio manager of Matthews China Small Companies, contends that smaller firms are arguably stronger financially than large firms which often rely on government loans. “They were capital-starved when they were growing up, so they had to generate their own cash flows. They don’t go out and spend two years building a building before getting their first cent. The customer better pay first,” she recently told The New York Times. She added that the best investments tend to thrive in industries that have grown with China’s middle class, such as consumer products and health care.
Across its stable of funds, Matthews Asia emphasizes an investment approach that is focused on developing deep insights into a geographic target region through fundamental research and identifying the most attractive long-term investment opportunities. Managers and analysts conduct in-depth, on-the-ground fundamental research and objective analysis to identify the most compelling opportunities while minimizing downside risk. Matthews says that this active approach allows them to drill down into lesser-known and less-followed businesses to identify opportunities that may not be readily visible to others.
This in-depth look includes the assessment of financial strength, resource allocation decisions, incentive structures, and more. Corporate governance plays a large role in the due diligence process. An appraisal of management quality includes how well management articulates and executes its long-term vision, as well as the ability of the company to grow sales and profits with attractive returns over the long term. Matthews meets with company management, makes trips to production facilities and warehouses, and often engages with employees, customers, supply chain partners, and competitors.
Manager Tiffany Hsiao states that she and the team are focused on “finding innovative and capital-efficient small companies that are relatively insulated from macroeconomic uncertainties. We . . . seek companies with sustainable, quality earning streams, strong cash flows, and good balance sheets that can weather uncertain economic conditions. We believe sectors such as industrial automation, consumer, health care, and technology are among the most attractive from a secular growth perspective.”
She told Barron’s, “We stress-test every company through all types of scenarios,” noting in a nation as big as China, “something will always go wrong,” whether it’s a virus, natural disaster, or something else. “We want the highest return on capital possible. To do that, we tilt toward asset-light companies that don’t have much balance sheet risk.”
Hsiao notes that the fund is heaviest in health care and technology. In health care, half of the fund’s allocation “pertains to basic stuff like vaccines,” she told Barron’s, plus areas including medical waste and health care infrastructure. The other half is focused on human DNA, especially in treating critical-illness diseases such as cancer.
In technology, the fund is a big investor in software, for example, China Youzon, which Hsiao explains is the Chinese equivalent of Shopify, which helps small businesses transition to selling online. It also has holdings in the digital economy, for example, online education. The fund’s largest holding, Silergy, is also one of its strongest recent performers, with a one-year gain of 263%. Silergy, the largest analog semiconductor company in China, expects to grow revenues between 20% and 30%. The firm’s chairman has noted that the company’s business areas are those the government wants to accelerate, including 5G infrastructure, health care equipment, and data centers.
Matthews China Small Companies has had an overall admirable investment performance. It ranks in the top 2% of its peer group for the trailing one-, three-, and five-year periods, as well as in 2020 to date, with a 37.0% gain.
Brian W. Kelly, Moneyletter, moneyletter.com, 800-890-9670, June 2020