Sept. 3, 2004 — The Matthews Asian Technology Fund (MATFX) could be a considered a sector within a sector fund.
Lead manager Mark Headley invests in technology companies in Asian Pacific nations, including Japan. While the fund is typically concentrated with about 50 stocks, Headley seeks to diversify by holding a broad range of tech-related companies, including computer and software manufacturers, Internet service providers, wireless telecoms, and semiconductor producers. Headley can invest in large-cap global leaders like Samsung Electronics and Nintendo, as well as smaller companies like Internet Auction.
The $40.1-million portfolio has delivered some impressive returns since its inception in late 1999, at the tail end of the global tech boom. For the one-year period through August, the fund gained 12.4%, while its benchmark, the MSCI/Matthews Asian Technology Index, rose 0.6%. For the three-year period through August, the fund climbed 11.4%, on average, versus a 3.6% gain by the index.
Reflecting the considerable volatility of foreign tech investing, the fund has a high standard deviation of 27.8%, versus 23.0% for its international equity fund peers, although it boasts a significantly lower turnover of 72.0%, compared with its peers’ 116.1%.
Patricia Higase, an analyst on the fund, estimates the universe of investible Asian tech stocks with a minimum market cap of $100 million is about 770 stocks, for a total market cap of $1.4 trillion. A year ago, the comparable number was 640 stocks, with a $1.2-trillion total market cap. Using a bottom-up, growth-at-a-reasonable price approach, Headley and his team consider this universe to build a concentrated portfolio of 45 to 50 holdings.
The fund’s five largest holdings show the fund’s diversification: Samsung Electronics Co. Ltd., the Korean consumer and industrial giant, which accounts for 30% of the Korean market’s total capitalization, 4.4% of the fund; Internet Auction, the Korean version of eBay Inc. (EBAY), 4.0%; Nintendo, the Japanese home video-game manufacturer, 4.0%; NIWS Co. Ltd., a Japanese financial software firm, 3.7%; and Hon Hai Precision Industry Co., a Taiwanese cable assembly maker, 3.6%.
These five holdings represent nearly 20% of the fund’s assets.
The fund is dominated by stocks in information technology, 57.5% of the fund as of July 31; followed by telecommunications services, 20.9%; and consumer discretionary, 14.3%.
Headley cites Korea’s Internet Auction as an example of newer, smaller companies he likes. “When we first invested in Internet Auction, it was not profitable,” he said. “But we liked their management team, and we knew that Koreans have the highest level of broadband penetration in the world and adopt new technologies very easily. Thus, the environment was good for this company. For these money-losing start-up techs, the quality and honesty of management is very important. Internet Auction has been very successful, maintaining its domination of the domestic auction business, and delivering high profitability. It has done so well that eBay owns 50% of the company’s shares and is seeking to swallow it up entirely.”
However, geographic diversification can only go so far. The region’s region’s two biggest economies, Japan and Korea, account for more than half of the fund’s assets. The increasingly important China/Hong Kong hub represents 20% of the fund, so only three markets make up more than 70% of the portfolio’s assets.
Headley counters that the fund is underweight in Japan relative to its benchmark. “We are disappointed that the restructuring of the Japanese tech companies has been slow,” he said. “Samsung of Korea has eclipsed many Japanese tech firms, representing a failure by senior management in Japanese companies to become profitable. They have also been hurt by the weak domestic economy in Japan. But I think Japan may have turned the corner. We are currently looking for some Japanese tech stocks, particularly Internet names, that are poised to benefit from a potential recovery in Japan’s domestic segment. If and when that domestic economy recovers, it will unleash huge earnings growth for local-oriented Japanese companies.”
Headley said he believes the political risks commonly associated with South Korea have been exaggerated and are already priced into the market. “Korea has a dynamic domestic economy that has successfully integrated with both high-end Japan and low-end China,” he noted. “Korea has embraced Western-style management quicker than Japan has.”
Headley currently has relatively little exposure to the semiconductor industry, aside from Taiwan Semiconductor and Samsung, two core holdings in the fund. “The chip industry is very volatile, prone to rapid swings and prices,” he noted. “It’s difficult to make accurate forecasts about this industry.”
Headley is not overly concerned about the weak dollar and its effects on Asian tech exports. “A weak dollar will only hurt Japanese firms because the other major Asian countries are managing their currencies down with the dollar,” he said. “Many Japanese tech stocks tend to move not on fundamentals, but on the vagaries of the yen. When the currency is weak, foreign investors buy them, and then they sell when the yen strengthens.”
In either case, Headley is trying to avoid investing in companies which are overly sensitive to the U.S. economy, although he will hold onto global leaders like Nintendo, which has a large exposure to the U.S consumer market.
Headley will unload a stock because of valuations or if an industry’s outlook darkens. “But a company’s outlook is often determined by what kind of market the company serves,” he explained. “Is it a global company or is it domestically-oriented? China Mobile is a giant blue-chip which serves the domestic Chinese mobile market, whereas Canon plays in the global marketplace in several different industries. When making sell decisions, we have to consider various factors, not just valuations.”
While many Asian tech stocks are trading at depressed prices — for example, Samsung has a p/e of about 8 — Headley is ebullient about the industry. “The Asian tech sector is just as dynamic and complex as the U.S. tech industry,” he said. “Many Asian companies enjoy global dominance and are of the highest quality. Once we get through the current worries about terrorism, high oil prices, high interest rates, and the weak dollar, Asian tech stocks, particularly those in Japan, could flourish.”
Contact Bob Keane with questions and comments at: [email protected].