When Andrew Mattock first began visiting China nearly 20 years ago, it took him about a week to drive 1,000 kilometers (620 miles) deep into the country.
Now Mattock, lead manager of the $1.1 billion Matthews China fund (ticker: MCHFX), can jump on a high-speed train and cover the same distance in four hours, allowing him to get even further into the country to see the diversity and different stages of China’s development in smaller cities.
Back in 2000, there were not many Chinese companies accessible to foreign investors. So Mattock spent much of his time meeting with local government officials, property developers, and bankers to cobble together a view of the economy by understanding what industries were being developed, who was buying property, and what sectors were getting financing.
Now, with thousands of companies listed, Mattock spends about half his time with management, since data, even if sometimes dubious, is plentiful. He often finds that the inland cities look a lot like the ones that were getting great attention a decade ago on the country’s east coast.
The one constant over the years has been change. As China’s economy matures, new industries have popped up, reshaping the composition of the stock market away from manufacturing toward services and technology—and sometimes turning winners into losers.
“China demands that you be open to new ideas,” Mattock says. “A buy and hold strategy wouldn’t have worked over the past 15 years. You have to be nimble. Excess profits are competed away. Then you end up with a bloodbath, and then a new industry emerges to trump the last hot one.”
Mattock, 43, grew up in Sydney, Australia, and learned about the challenges of small-and mid-size businesses helping out in his father’s chartered accounting business. He studied accounting and worked at PricewaterhouseCoopers, providing accounting for pension firms’ investments. But he soon decided he wanted to invest himself and joined Henderson Global Investors in 2000, where he eventually helped manage Asia-related funds from Singapore.
Mattock joined Matthews Asia in 2015 and has developed a reputation around the company’s San Francisco office as a “data hoarder” who often pulls out tidbits from companies, industries, and companies around the world while playing devil’s advocate on a range of topics. In a market prone to swings between being overly exuberant and overly depressed, seeing all sides has served Mattock well over the three years he has led the fund—it has averaged a more than 11% annual return a year over that period to beat 85% of its China peers, according to Morningstar. It did even better over the past year, returning 45% as Chinese stocks rebounded, beating 94% of its peers.
China’s economic growth is expected to slow. But as fears about the pace of deceleration loom over the market, investors are missing pent-up consumer demand, Mattock says. For years, the government focused its lending on industrial businesses, but that is changing as China tries to shift toward a more consumer-driven economy and technology accelerates the launch of more service-oriented businesses. Consumers now can find services that were unavailable a couple years ago, from movie theaters and car washes to being able to order Nike shoes online in a small city without waiting for a retailer to carry them.
“Income is growing 10% per annum; households have a savings rate of 35%, and there are too many, too big cities to put an exact number on the demand,” Mattock says. “But you know the potential is skewed massively on the upside.”
Rosy prognostications come with risk, which is why Mattock, along with co-managers Winnie Chwang and Henry Zhang, is taking precautions. The fund invests across China, looking for companies with at least $1 billion in market value in shares traded in Hong Kong and $3 billion for those listed in the Shanghai and Shenzen A shares domestic market. The fund concentrates on high-conviction ideas to minimize mistakes in a rapidly changing market, with the top 10 of its 47 holdings accounting for about half of assets.
The managers are also careful about how much they will pay for growth, with the average price/earnings ratio in the portfolio just 12 times, compared with 14 for its peers. About 11% of assets are invested in China’s A shares market. Though it could get a boost as more U.S. investors hunt in the yuan-denominated market after it is included in broad emerging market indexes, Mattock says valuations in Hong Kong-listed H shares are more attractive at the moment.
Mattock favors companies with above-average earnings growth over the next five years, strong cash flow and balance sheets, and solid management—pretty typical fare for managers who favor quality growth. But China comes with its own idiosyncrasies. With 1.4 billion people, volume growth is easy to come by, often setting up a race to the bottom in terms of pricing that erodes margins. Plus, brands are still new, making them vulnerable to competition. As a result, paying close attention to how industries are structured is key, Mattock says.
Ping An Insurance Group (2318.Hong Kong) and appliance maker Midea Group (000333.China) are two holdings that have survived consolidation and still have strong growth ahead, he says. Ping An, for example, has been quick to keep up with changes in its business, leading the shift onto the Internet and cross-selling its financial services.
Internet companies like Baidu (BIDU), Alibaba Group Holding (BABA), and Tencent Holdings (700.Hong Kong) have benefited from gigantic first-mover advantage. Alibaba is the fund’s top position, at more than 10% of assets. Tencent is at its lowest weighting since 2015—6.3%—in part because there are cheaper options. As the company faces higher costs amid increasing competition, earnings in some parts of the business could also come under pressure, Mattock says. Though the trio of stocks gets much of the attention, Mattock also likes other ways to invest in digital trends, including information technology company Chinasoft International (354.Hong Kong) and Baozun (BZUN), which helps companies with e-commerce marketing and fulfillment.
Mattock is also finding earnings growth among cyclical stocks as China reforms its state-owned enterprises to reduce overcapacity and push through environmental measures. For example, cement prices are rising as plants are being shut, improving the fortunes of China National Building Material (3323.Hong Kong), the world’s largest cement maker. Meanwhile, China’s environmental push benefits China Everbright International (257.Hong Kong), which focuses on water and waste treatment and biomass power generation. The company has finished construction on many of its projects, freeing up cash flow, Mattock says.
Trade concerns ebb and flow with the day, but he argues China is more self-sufficient than in the past, and notes that most of his holdings are domestically oriented and less vulnerable to trade rhetoric. For him, a tumble in China’s property market poses a bigger risk since it could affect consumer demand.
As a stock picker, though, the biggest challenge is finding winners in a larger universe with more companies, across a wider swath of the country. History offers some help. “Understand the past,” Mattock says. “It won’t be the future, but it lets you attempt to see a range of possibilities.”