But valuation isn’t always a clear-cut concept. For example, Morningstar’s analysis of the Matthews Asia Innovators Fund shows that its portfolio is significantly more expensive than its category and benchmark index when analyzed by the main valuation ratios, including price-to-earnings, book, sales and cash flow.
“It’s true that by using traditional metrics these companies tend to look more expensive,” Oh says. “At the same time, many of these companies are the major platforms in the region, and these companies have a lot of intangible assets that make them look more expensive by using traditional metrics such as price to book. For example, Bilibili is the dominant player in its space, and it has a large user base asset that’s not reflected in its book value.”
Bilibili Inc. is the YouTube of China and was the fund’s largest holding through the first quarter. “It’s adding users at little marginal cost to grow its networking effect, and it has a dominant share of the Z Generation, who love to create and share content,” Oh says. “In my opinion, its full potential isn’t reflected in the market today. It has been a great performer and has contributed to the fund’s performance during the past few years.”
Another top holding in the Matthews fund is Sea Ltd., a Singapore-based internet company that Oh says has dominant market positions in both e-commerce and online gaming in Southeast Asian countries such as Singapore, Indonesia and Thailand.
“Plus, Sea is developing its fintech division, and it recently won a digital banking license in Singapore which they can use as a platform to launch into other countries in the region,” he notes. “It’s also becoming one of the major mobile payment systems in the region, too.”
Oh manages a highly concentrated, high-conviction portfolio of 30 to 50 names. The target holding period is three to five years, and the annual turnover rate has been roughly 30% to 50%. “However, in the past few years markets have been volatile, so taking advantage of market volatility has contributed to higher turnover,” he says.
China’s Risk/Reward Proposition
China has been both a regional and global growth driver for most of this century, so it’s no surprise that it’s the largest country allocation by a mile in the Matthews Asia Innovators Fund. But Oh recognizes that current happenings in China make some investors nervous, such as the Chinese government’s heavy-handed presence in that nation’s economy and financial markets (for instance, last year the government put Alibaba Group founder Jack Ma in his place by blocking an IPO of one of his companies after officials decided he was getting too big for his britches). Internet platforms have gotten bigger, prompting the Chinese government to worry about anticompetitive behavior and powerful media platforms. Ma had also started to criticize government policy.
“China sounds really bad just looking at the headlines,” Oh acknowledges. “I think Korea and other more developed countries went through periods of government intervention in the past. When it comes to sensitive industries like online gaming or the internet—areas that touch the everyday lives of consumers—Asian governments “like to intervene in these areas.”
He says Jack Ma’s case was different. “They tried to make him an example to show that Chinese entrepreneurs should focus on building their businesses and not try to interfere with the country’s policy making,” Oh says. “We’re not here to judge whether the policies are correct. We’re trying to understand the regulatory risks in Asia, because they do exist, and to navigate the market knowing that.”
Though the Matthews fund has enjoyed a stellar track record, that hasn’t kept it from hitting bumps in the road. It had a slightly negative year-to-date return as of early May, underperforming both its category and benchmark, and finding itself in the doghouse—the bottom quartile of its category.
The fund’s first-quarter commentary report noted that sentiment had turned negative toward the Asian large caps and growth stocks that make up the bulk of its portfolio. Nonetheless, some investors might view this hiccup as a buying opportunity.
The fund’s growth profile carries some risk, and it sports a higher standard deviation than its category and benchmark over three-, five- and 10-year periods. Morningstar has labeled it as a “high” risk fund for its category in the three- and five-year time frames.
“We view risk as the permanent loss of capital,” Oh says, adding that the fund tries to avoid that by buying companies below their intrinsic value.
“We believe that Asian markets are inefficient and benchmarks tracking Asian markets tend to be backward looking,” he says. “I believe our portfolio, which is very different from the benchmark, represents the future of Asia.”