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Matthews Asia: Q&A With Robert Horrocks, PhD

Q&A With Robert Horrocks, PhD by Matthews Asia Chief Investment Officer and Lead Manager, Matthews Asia Dividend Fund Matthews Asia: How do you view the market environment for Asian economies? Robert Horrocks: The biggest negative in the short term is the U.S. Federal Reserve raising interest rates, meaning potential currency weakness and capital outflows for Asian markets. The main question is whether growth will pick up in an environment where markets are weak. In the short term, we are also seeing aggressive monetary stimulus across Asia: in China, India, Taiwan and Korea. The long-term outlook is, however, more upbeat. First, current accounts in Asia are generally positive: Asian countries are saving more domestically than they invest and are relatively less reliant on foreign capital. Asia has a higher share of manufacturing as a percentage of GDP and higher productivity growth, compared with the rest of the world. This started from a low base and has improved significantly over the past 20-30 years. Matthews Asia: How do you mitigate volatility? Robert Horrocks: The behavior of a dividend portfolio tends to be less volatile than the market: the security of receiving a dividend yield enables us to pursue a reasonable level of total return without chasing faster-growing, but more volatile investments. That is a double-edged sword, however: if the market goes up, we do not necessarily follow at the same pace. But in down times, we may have an element of protection. Matthews Asia: How is the Matthews Asia Dividend portfolio structured? Robert Horrocks: We take an all-cap approach, meaning we can invest in anything from small to mega caps. What is nice about Asia is that you see companies right down the market cap paying dividends. In small and mid-caps, you tend to find more entrepreneurial companies, family-owned commercial businesses, while large companies in Asia are often less commercially run and connected to governments. The market capitalisation of companies we invest in depends on the liquidity of underlying stocks in a particular market. For some markets, a liquid stock would have to be $1 billion, for others, only a few hundred million. But one thing this Fund will not do is morph into a blue-chip yield portfolio. Matthews Asia: What differentiates the Matthews Asia Dividend Fund from other Asia income funds? Robert Horrocks: We believe it is important to focus on the sustainability of the dividend stream. Many Asian equity income portfolios are built with a lot of emphasis on yield, containing stocks of Chinese and Australian banks and commodities, for example, which can be difficult underlying businesses. In our long-term total return approach, we use dividends as an indicator of core earnings growth and strength of the company. The companies we seek to invest in range from small and mid-caps that may be yielding 2% to solid businesses that may yield 4-5% but potentially growing their dividends at a 15% rate. This balanced approach seeks to create a portfolio that can benefit from an attractive dividend yield without giving up on growth. We have a lot of flexibility: If the market is hot, the natural thing for us is to take a step back and look in the other direction. If everyone is looking for yield, we would look for growth; if they start paying more for growth, we would move the portfolio back towards yield. We have a dedicated team of investment professionals that have 2,500 company meetings every year, looking at all businesses through the Asian dividends framework. We also meet with companies’ competitors and suppliers to gauge their outlook. Matthews Asia: Where are you currently wary of investing? Robert Horrocks: The Fund has currently no allocation in Australia. A lot of the time, the Australian banks or the material sectors are quite cyclical and exposed to shocks, both internally and externally. There are some countries that are more fertile ground than others. In India, for example, it is difficult to find high-quality companies, which are giving you a particularly high current yield. Now the reason for that is capital is quite scarce in India – after you have reinvested it into the business, there is less to pay out. Also, valuations there tend to be a little bit higher than in the rest of the region, so that is where the valuation discipline of the Fund comes in. In places like Korea, there is a lot of capital that can be shared with minority shareholders, but historically, the attitudes of management teams there has been less favorable to shareholders. That is where the corporate governance side of the discipline of our framework comes in. Matthews Asia: What are some of the most prevalent investment themes in Asia? Robert Horrocks: Looking at the past 30 years, inequality across the world has been decreasing (although it could be increasing within certain individual countries). This development has resulted in the rise of the middle class, so an opportunity for us is to find companies that will facilitate that middle-class life. This is an ongoing trend, likely to continue for the next 30 years. According to the Organization for Economic Co-operation and Development’s estimations, by 2060, Asia will account for two-thirds of middle-class spending in the world. Companies that should gain from that spending include businesses in industries as varied as retail, consumer staples and goods, consumer discretionaries, autos, media, leisure, entertainment, tourism, insurance and wealth management. Consumer and auto loan businesses of banks as well as healthcare are also expected to benefit – whether it is a high-street establishment or a more sophisticated business, such as a healthcare equipment manufacturer, a private hospital or a drugs company. Click to enlarge Robert Horrocks – Image source: Matthews Asia See full PDF below. Disclosure: None

Seeking The Asian Sanborn Map

Buffett’s Investment In Sanborn Map Warren Buffett wrote at length about his investment in Sanborn Map, a publisher of maps of U.S. cities and towns, in the Buffett Partnership’s 1961 letter . Sanborn Map represented 25% and 35% of assets for the Buffett Partnership in 1958 and 1959 respectively. Sanborn Map was referred to as a company which “published minutely detailed maps of power lines, water mains, driveways, building engineering, roof composition, and emergency stairwells for all the cities of the United States, maps that were mainly bought by insurance companies,” in Alice Schroeder’s The Snowball. According to Roger Lowenstein’s book “Buffett: The Making of an American Capitalist,” Buffett earned “roughly a 50 percent profit” on the investment in Sanborn Map. Going back to the Buffett Partnership’s 1961 letter, Warren Buffett shared how he exited the investment at a profit by exercising influence by virtue of his significant shareholdings: Our holdings (including associates) were increased through open market purchases to about 24,000 shares and the total represented by the three groups increased to 46,000 shares. We hoped to separate the two businesses, realize the fair value of the investment portfolio and work to re-establish the earning power of the map business…There was considerable opposition on the Board to change of any type, particularly when initiated by an outsider, although management was in complete accord with our plan and a similar plan had been recommended by Booz, Allen & Hamilton (Management Experts). To avoid a proxy fight (which very probably would not have been forthcoming and which we would have been certain of winning) and to avoid time delay with a large portion of Sanborn’s money tied up in blue-chip stocks which I didn’t care for at current prices, a plan was evolved taking out all stockholders at fair value who wanted out. The SEC ruled favorably on the fairness of the plan. About 72% of the Sanborn stock, involving 50% of the 1,600 stockholders, was exchanged for portfolio securities at fair value. The map business was left with over $l,25 million in government and municipal bonds as a reserve fund, and a potential corporate capital gains tax of over $1 million was eliminated. The remaining stockholders were left with a slightly improved asset value, substantially higher earnings per share, and an increased dividend rate. Sanborn still exists today and has transformed itself into a provider of “a full suite of photogrammetric mapping and geographic information system (NYSE: GIS ) services,” according to its corporate website . Sanborn Map ‘s Deep Value And Wide Moat In many ways, Sanborn Map represented a classic deep value cigar-butt investment that Benjamin Graham would have been proud of, although the company had elements of a wide moat (albeit diminishing) investment as well. In 1958, when Buffett first initiated a position in Sanborn Map, the stock was trading for $45 per share, compared with the company’s investment portfolio of stocks and bonds valued at $65 per share. This implied that the market was valuing Sanborn Map’s map publishing business at -$20 per share, suggesting that investors vested at current prices were getting the map business for free. I have written extensively about deep value bargains net of cash and investments in my articles “How Benjamin Graham Will Possibly Invest In A World Without Net-Nets,” “Seeking Value In Sum-Of-The-Parts Discounts” and “A Case Study On Large-Cap Value Investing” published here , here and here . Sanborn Map was also a wide-moat company in various aspects. Firstly, Sanborn Map dominated its market, as evidenced by Buffett’s choice of words in his letter “For seventy-five years the business operated in a more or less monopolistic manner.” Secondly, Sanborn Map enjoyed a high degree of recurring revenues. Maps required annual revisions (via pasteovers), for which Sanborn Map will charge its customer around $100 every year. Thirdly, customer demand was fairly predictable (insurance companies needed maps to assess risk and underwrite policies) and Sanborn Map did not need to invest heavily in marketing to retain its customers. Sanborn Map’s moat eventually narrowed as its key clients, the insurance companies merged, which meant less business and more powerful customers. Furthermore, “a competitive method of under-writing known as “carding” made inroads on Sanborn’s business and after-tax profits of the map business fell from an average annual level of over $500,000 in the late 1930’s to under $100,000 in 1958 and 1959″ according to Buffett. Asia’s Sanborn Map Japan-listed OYO Corporation (9755 JP) is potentially Asia’s Sanborn Map. OYO Corporation call itself the “Doctor to the Earth” and its corporate profile on the Japan Infrastructure Development Institute website reads as follows: OYO Corporation was founded in 1957 as a general consultant firm specializing in study of the earth by Dr. Fukuda and Dr. Suyama. OYO brings together geology, geophysics and geotechnical engineering to provide a wide range of services in the four fields of construction, resources, disaster prevention and environment. In addition to these technical services, OYO is continually expanding its development of measuring instruments based on our own abundant experience in the field.To date OYO has grown up to the largest specialist organization in Japan in geotechnical field. OYO has about 1,100 staffs, more than two-thirds of them are university graduates in engineering and scientific fields. Besides some 60 numbers of domestic branch offices, we have overseas branches and subsidiary companies in U.S.A., U.K.,and J.V. in France. OYO has devoted itself to research and development in an effort toward “The Creation of Geoengineering.” Our greatest desire is to apply our achievements and to provide services of higher quality to our clients and customers throughout the world. OYO operates in three key business segments: Engineering, Consultation and Instruments. The Engineering business provides ground structure information for the major motorway constructions in Japan; assists with post-disaster management by conducting investigations to recommend relevant repair work; conducts air, land and sea-born investigations for natural resource explorations; and does site investigation for pollution remediation projects. OYO’s Consultation segment involves itself in the site assessment and determination process of nearly all of Japan’s power plants; provides earthquake damage estimation to city planners; and conducts geotechnical investigations and subsidence forecasts for airports built on water. Its Instruments business develops measuring & monitoring instruments used for a wide range of purposes including monitoring the condition and movement of polluted underground water, seismographs for exploration of natural resources under the sea bottom, and geotechnical investigations from: shallow soft soil to deep hard rock structures on the ground and in the sea. OYO’s net cash and short-term investments of JPY 24.0 billion as of December 2015 currently represents approximately 77% of OYO’s current market capitalization, which values the company’s operating business at a mere 3 times trailing EV/EBIT. While OYO is not exactly as great a bargain as Sanborn Map, the stock is still the cheapest of listed companies providing surveying and mapping services. As a bonus for my subscribers of my premium research service , they will get access to: 1) a list of publicly-traded companies providing surveying and mapping services; and 2) a list of stocks with short-term investments exceeding their market capitalizations. Asia/U.S. Deep-Value Wide-Moat Stocks Premium Research Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of deep-value & wide moat investment candidates and value traps, including “Magic Formula” stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. The potential investment candidates I profiled for my subscribers in May 2016 include: (1) a U.S.-listed market leader in a niche consumer lifestyle space which is trading at 0.80 times P/NCAV and 0.70 times P/B, but remains debt-free and profitable; (2) a U.S.-listed Net Operating Losses-rich deep value play valued by the market at 2.6 times EV/EBITDA net of the present value of its NOLs; (3) an Asian-listed manufacturer of wireless communication products which is the market leader in its home market and the first to export such products to the U.S.; it is a net-net trading at 0.75 times P/NCAV with net cash equivalent to its market capitalization; (4) a U.S.-listed Magic Formula stock trading at 3 times trailing EV/EBIT and Acquirer’s Multiple, sporting a 10% dividend yield net of withholding tax; (5) a U.S.-listed Munger Cannibal trading at 7 times trailing EV/EBIT and Acquirer’s Multiple; (6) an Asian-listed company which is a global leader in a certain medical device niche trading at 3.5 times trailing EV/EBIT and 3.5 times Acquirer’s Multiple, versus a trailing ROIC of 27%. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

FBT Was +47.55% In 2014 And +10.00% YTD. Will The Returns Continue In 2016?

Summary This established Biotech ETF has an interesting structure but also is quite volatile. With $3.28BLN in assets, will the institutions continue to invest in 2016? We answer these questions and provide our recommendation on this top performer. The First Trust NYSE Arca Biotechnology Index ETF (NYSEARCA: FBT ) is an equal weighted passively managed fund with an established track record, (inception 06/19/2006). The fund seeks to replicate as close possible, before fees and expenses, the price and yield of the NYSE Arca Biotechnology Index, (previously the Amex Biotechnology Index). The interesting structure of the ETF is the 30 components, (previously 20 components prior to October 20, 2014). What is challenging for shareholders is the quarterly rebalancings that occur in late January, April, July and October. Due to the equal weighting objective of the Fund and the underlying Index and the general small to mid-cap nature of the sector, these rebalancings and the ETF, in general, can be volatile. We will analyze the structure of the ETF, its holdings, performance and fees and provide our recommendation. 100% of the ETF is in common equity holdings. Our Market Cap is quite simple, with most of our sources agreeing: FBT Market Capitalization Market Cap Weight Mid cap 34.98% Small cap 33.10% Large cap 31.98% These numbers were courtesy of Fidelity, with xtf.com extremely close in agreement. Morningstar, as we previously noted uses a slightly difference nomenclature. Their breakdown is: Medium at 40.56%, Small at 27.19%, Large at 23.12%, and Giant at 9.12%. Categorically we can state that the majority of the firms in this ETF are small to mid-cap firms with limited products presently, if any, in the marketplace. In terms of the style of the underlying components, it is quite clear to investors who have participated in this space. FBT Ownership Style Style Weight Growth 59.80% Pure Growth 30.00% Blend 7.10% Value 3.10% Without a doubt this ETF is a growth vehicle and not intended for those seeking value investments. Morningstar states that the ownership style is mid or medium and is considered high growth. In terms of currency and countries of the holdings it is somewhat interesting. FBT Country and Currency Exposure Country Weight Currency Weight United States 89.90% United States dollar 89.90% Ireland 3.68% Euro 10.10% Spain 3.23% NA NA Netherlands 3.19% NA NA Our country and currency exposure here is clearly US geographically focused with some Eurozone exposure as noted. The 10.10% euro weighting will not adversely impact this ETF even with the euro possibly moving below dollar-euro parity. As such, we have no issues with the underlying geographical or currency weightings. It is quite clear that the overall sector is 100% healthcare in FPT. The industry exposure is informative. Industry Weight Biotechnology 79.27% Life Sciences Tools & Services 16.29% Pharmaceuticals 4.47% While this is in no way diversified, it does show that there are companies within the ETF which are not pure biotech, but are grouped within the fund. Some of them we do recognize from previous research and there is one firm that we previously analyzed and recommended. We will discuss this firm when we review the holdings. In terms of the holdings, as usual we will analyze the top 15 components, their symbols, ratings, (Moody’s and S&P), if any, and their weight within the ETF and the underlying index {BTK}. In this fund’s case we will also show their individual year to date and 12 month performance. FBT top 15 holdings Name/Symbol YTD perf/ 12 month Ratings, (Moody’s/S&P) Weight-BTF Weight- Index, {BTK} Nektar Therapeutics (NASDAQ: NKTR ) 0.71%/-3.27% NR/NR 4.47% 3.33% Dyax Corp. (NASDAQ: DYAX ) 165.50%/168.18% NR/NR 4.10% 3.33% Isis Pharmaceuticals, Inc. (NASDAQ: ISIS ) -7.92%/-0.25% NR/NR 4.09% 3.33% Alnylam Pharmaceuticals, Inc. (NASDAQ: ALNY ) 0.74%/-8.18% NR/NR 3.93% 3.33% United Therapeutics Corp. (NASDAQ: UTHR ) 20.08%/16.21% NR/NR 3.78% 3.33% Celldex Therapeutics Inc. (NASDAQ: CLDX ) -16.33%/-17.19% NR/NR 3.70% 3.33% Alkermes, PLC (NASDAQ: ALKS ) 22.49%/22.62% Ba3/BB 3.68% 3.33% Illumina, Inc. (NASDAQ: ILMN ) -4.60%/-7.27% NR/BBB 3.64% 3.33% Charles River Laboratories International, Inc. (NYSE: CRL ) 18.73%/18.41% Ba2/BBB- 3.57% 3.33% Novavax, Inc. (NASDAQ: NVAX ) 36.09%/46.99% NR/NR 3.48% 3.33% Alexion Pharmaceuticals, Inc. (NASDAQ: ALXN ) -3.18%/-9.12% NR/NR 3.35% 3.33% Myriad Genetics, Inc. (NASDAQ: MYGN ) 25.54%/21.89% NR/NR 3.35% 3.33% Vertex Pharmaceuticals Inc. (NASDAQ: VRTX ) 2.52%/2.02% NR/NR 3.35% 3.33% Regeneron Pharmaceuticals, Inc. (NASDAQ: REGN ) 33.24%/25.67% Baa1/NR 3.32% 3.33% Amgen Inc. (NASDAQ: AMGN ) -0.62%/-5.91% Baa1/A 3.24% 3.33% The top 15 holdings represent 55.05% with an average of 3.67%, with the bottom 15 totaling 44.96%. This was expected with the equal weighting of the ETF. Unlike the index which is even at 3.33% or 1/30 for each holding, the ETF is adjusted for share price and an equal value. Based upon the individual performance of the top 15 holdings, it is fairly obvious that returns are not reasonably predictable without extensive analysis of each company, their future products and FDA approval developments. The equal weightings here do provide an opportunity of participating in one of the top performers, such as Dyax Corporation with a 165.50% return YTD. Obviously, the return on Dyax far outweighs the negative return of a firm such as Celldex Therapeutics at -16.33% YTD. The benefit of the ETF allows participation in a sector where returns can be quite diverse from one firm to another. In terms of credit ratings, only 14.13% (S&P) of the top 15 have ratings and only 25.66% of these 15 holdings. It is quite apparent that with the rapid growth and negative balance sheets of these firms, the majority of the firms are mostly lower grade credits, if rated at all. Only Illumina, Inc., Charles River Laboratories International, Inc and the well known Amgen Inc. are investment grade, as per S&P. One of the firms in the ETF with a weighting of 2.91% is our personal favorite, Quintiles Transnational Holdings, Inc (NYSE: Q ), a company we had previously analyzed and recommended. Quintiles is the leader in {CRO} services or a Contract Research Organization. The company basically performs many of the services that large pharmaceuticals and Biotech firms require to bring their product to market and to continue to develop new and existing products. This would include Consulting Services, Portfolio and Strategy Planning, Clinical Trial Execution, Laboratories, Real-World and Late Stage Trials, Technology Solutions, Patient and Provider Engagement, Product Marketing and Sales. We are a little surprised to see it in this ETF. It is a profitable and quite a large capitalized firm, yet it will continue to grow and profit as long as there is a need for their services from the healthcare sector. As such, we think it is a great way to participate in the overall growth of the firm (14.51% YTD/18.26% 12 month) balanced with the performance of the other holdings in the ETF. Based upon the components and structure we analyzed the overall performance of the ETF and the index. FBT’s Performance, Fees and Recommendation Category FBR {ETF} BTK {Index} Net Expense Ratio .58% NA Turnover Ratio 58.00% NA YTD Return 9.94% (11/30/15) 5.99% (12/07/15) 10.66% (11/30/15) 5.48% (12/07/15) 1-Year Total Return 10.08% (11/30/15) 5.56% (12/07/15) 10.79% (11/30/15) 5.58% (12/07/15) Dividend Yield/SEC Yield 0.17%/-0.43% NA Beta (Shares/Holdings) 1.13/.70 NA P/E Ratio FY1/current 29.60/26.93 NA Price/Book Ratio FY1/current 8.00/7.06 NA Our expense ratio is in-line with the asset class median of 0.53% and is quite acceptable. Our turnover ratio is only slightly surprising here. With an asset class median or 18.00%, we expected much higher. One of the reasons is the general nature of the sector and the rules of the ETF and the underlying index that cause firms to be replaced. According to the NYSE Arca: Components will be removed from the index during the quarterly review if they fail any of the criteria below: (1) Current Market Capitalization is lower than $900 million (2) The Average Daily Traded Value for the past 3 Months is lower than $900,000 (3) The Current Last Traded Price is less than $1.00 In addition, various corporate actions may cause the stocks in the index to be substituted. As there has been M&A activity and various other corporate actions in the sector over the past year, the high turnover ratio is to be expected here. In terms of the ownership of the ETF, it is readily apparent that institutions and funds hold large holdings. While Wells Fargo (NYSE: WFC ) holds 6.31% and Morgan Stanley Smith Barney LLC (NYSE: MS ) holds 8.81%, the big surprise holding is another ETF that we previously analyzed and recommended. The First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ), holds 33.99% of the total shares in its ETF or 24.20% of the total assets. The ETF has performed well due to its allocation in FBT, among others. FBT will continue to attract institutional shareholders and advisory clientele who seek allocation to the Biotech sector, regardless of economic conditions. In terms of economic conditions, many consider Biotech as being within the Pharmaceutical and medical space and defensive. We tend to agree, yet the cost of capital for the industry is always a concern. With interest rates set to rise this may be an issue for those firms which tend to borrow heavily to fund R&D. As such, though we are impressed with the performance over the past year the ETF is not for the squeamish. It is noted above that the YTD performance has dropped 4.00% since the end of November. The sector and its holdings are not for investors who are looking for the short term. A dollar cost strategy may be appropriate for investors who are familiar (or not familiar) with the frequent market routs. In terms of FBT the year high on July 20,2015 was $132.21 representing at that time a 28.96% YTD return, while the year low of $64.08 set on August 24,2015, after the Asia sell off, represented a loss of -37.49% YTD at that time. Overall, the volatility of the sector has not dissuaded institutional investors, (or speculators for that matter) from participating in this ETF or the sector. As the second largest biotech ETF, after the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) it continues to represent an attractive vehicle to participate in a sector that will continue to produce new drugs and redevelop existing treatments. We are a strong buy on this ETF into 2016 and beyond.