China Shares Still Hold Promise

Some Chinese stocks got thumped recently when investors were spooked by actions China's government took to rein in the country's tech and tutoring companies. But the supervisory moves were no surprise to old China hands, says Winnie Chwang, comanager of Matthews China (MCHFX) and Matthews China Small Companies (MCSMX).

"Regulation in China is part and parcel of a macro-reform agenda that's ongoing," she says. "We do not think this is an effort to stifle private business entrepreneurship in China."

Foreign investors dominated the sell-off, which was concentrated in well-known tech stocks such as Alibaba Group Holdings (BABA) and Tencent Holdings (TCEHY). The more domestically focused China A-share market gained a robust 16% over the past 12 months, while the broad China market, as measured by the MSCI China Index, lost 4%.

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Chwang, who manages both funds with Andrew Mattock, knows all about the A-share market. That's the focus at the Matthews China fund. The managers comb through roughly 2,200 candidates to find growing, high-quality companies of any size trading at reasonable prices. Once they've narrowed the list to about 150, they like to get a 360-degree view of a company before settling on some 35 to 45 stocks.

The bright spot of late is the managers' other fund, Matthews China Small Companies, which has a chart-topping 26% five-year annualized return. The managers follow the same investment process with the Small Companies fund as with the China fund, but they focus on firms with a market value between $1 billion and $5 billion.

Fast-growing technology and healthcare companies dominate the Chinese small-cap market, says Chwang, so close to 30% of the fund's assets are invested in those sectors. "Entrepreneurship is important to China's economic engine," she says. "These small companies contribute 60% to the country's overall gross domestic product growth."

Chwang expects Chinese stocks overall to post earnings growth of 10% to 15% over the next three to five years. And shares are relatively cheap: China stocks trade at 14 times expected earnings for the year ahead; U.S. shares trade at 22 times earnings.