For equity investors, the point of investing in emerging markets is to get something different from what they’d get in U.S. stocks. So what happens when an Asia-focused fund invests in exporters hitching their wagons to the U.S. market? Does that defeat the purpose?
That quest for genuine non-correlated assets underlies the Matthews Asia Innovators Fund, which looks for Asian companies primarily selling into fast-growing Asian markets.
“When my clients buy into an Asian asset class, they want exposure to growth in Asia; they’re not looking to buy into a derivative of U.S. technology companies,” says Michael Oh, the fund’s lead manager. “I’m trying to provide a pure Asian growth story.”
The fund’s long-term track record suggests its approach has been a winner. It launched in late 1999, and Oh became the lead portfolio manager in 2006. According to Morningstar, the fund has comfortably outpaced its category and benchmark during the last one-, three-, five-, 10- and 15-year periods. Not surprisingly, it has landed within its category’s top quartile in each of those periods.
Oh is backed by Matthews’s 40-plus member research team, which has boots on the ground in Asia with offices in Hong Kong and Shanghai. They focus on two overarching long-term trends that Oh says have existed in Asia for the past 20 years and will likely continue for the next 20 to 30: an expanding middle class in the region and its rising disposable income.
Because there are many growth opportunities emerging across the sprawling Asian landscape, Oh conducts his search for innovative companies within the context of what’s happening within individual countries. “In China, we see biopharmaceutical companies as the most exciting and innovative companies in that country,” Oh says. “Whereas in India, half of the population is unbanked, so we see companies providing basic banking services as among the most innovative companies there.
“Our sector and country allocations are purely driven by the secular growth opportunities we see in the region, and the companies we find from a bottom-up stock picking process,” he adds.
As of this year’s first quarter, the fund’s largest country weightings were in China/Hong Kong (nearly 59% of its holdings) and India (14%). Those country weightings are greater than those held in the fund’s benchmark, the MSCI All Country Asia ex Japan Index.
Conversely, the portfolio underweights the benchmark in Asian economic powerhouses South Korea and Taiwan. “A lot of the companies in Korea and Taiwan tend to be exporters geared toward the U.S. and European markets,” Oh says.
Innovation’s Many Forms
“Most people associate ‘innovation’ with breakthrough products,” Oh explains. “But we have broadened that concept to include companies that are implementing new ideas to build great businesses in Asia. That includes companies that are building products and services to create new markets or gain market share, as well as companies using innovative strategies to build entry barriers and sustainable competitive advantages.”
That means the companies the fund looks for are thinking differently about things like their corporate structures, strategies, marketing and customer relationships, how they manage supply chains and the way they incentivize management. “We try to use innovation as a filter, or a lens, to spot good quality growth companies in the region,” Oh says. “That’s our framework.”
When looking at metrics, he and the Matthews research team ask how much a company’s revenue goes toward research and development. To ascertain the effectiveness of that spending, they gauge how much a company’s sales come from new products, as well as the margins on those new products.
The final piece of the puzzle centers on a company’s valuation. The Matthews approach employs a discounted cash flow model and total addressable market analysis to gauge a company’s potential market cap.
“We generally look for companies that can double in the next five years and can deliver between 10% and 15% growth per year,” Oh says. “If we think the valuation is reasonable, it will enter the portfolio; otherwise, it goes on our watch list and we will wait for the right entry price.”