Commentary

Quarter Ending March 31, 2008

During the first three months of 2008, the Matthews Asian Growth and Income Fund declined
-4.25%, while its benchmark, the MSCI All Country Far East ex-Japan Index, fell -12.61% during the same period.

Markets around the world were racked by volatility as the contraction of the U.S. credit cycle exposed the terminal weakness inherent in the balance sheets of several major financial institutions, most notably Bear Stearns. Capital markets in Asia Pacific declined in sympathy, and on concerns that the region’s growth would stall if global demand faltered. Amid this environment, the Fund performed largely in line with expectation: It weathered the worst of the downturn well, outperforming both Asian markets and the S&P 500 on a relative basis.

The portfolio experienced several successful events during the quarter. Most notable of these was its investment in HSBC Holdings, which represented 3.0% of the portfolio at quarter end. For some time now, the bank has been under pressure. Even as profit growth has been steady, some investors have publicly declared their doubts about the bank’s management and the performance of its shares. Analysts also moved quickly to downgrade the bank’s earnings, assuming that HSBC would fall victim to the U.S. subprime debacle. Yet in recent months the bank’s leadership has become clear. In the latter half of 2006, before the credit crisis became fodder for headlines, the bank was one of the first to recognize the burgeoning problem, and undertook actions to clean up its balance sheet accordingly. In mid-2007, HSBC again lead the way as the first bank to bring its off-balance sheet interests back on the balance sheet. This was not just a show of strength; in doing so, the bank rejected common wisdom that a much-touted, government-led Structured Investment Vehicle (SIV) “superfund” was a viable alternative to help calm debt markets. The superfund never materialized, leaving competitor banks to scramble for a solution. In March, HSBC declared growing earnings for the year, and further that it would pay its dividend in full, and raise it for the year ahead—this came even as many of its competitors cut dividends and sought new sources of capital.

Of course, the portfolio was also not without its share of frustrations. Over the past few years, the Fund has increased its allocation to technology-related shares. The exact premise for each investment in this area has been different, but the general idea has been that such companies were available at lower valuations, had underappreciated growth prospects, solid balance sheets and improving cash flow. However, this fundamentally driven premise did not fare well during the first quarter, when concerns about the health of the global economy led many investors to sell technology-related shares in knee-jerk fashion. We continue, however, to see long-term prospects for the Fund’s holdings in this sector, as valuations and fundamentals remain attractive.

The portfolio also struggled under the weight of one of its larger holdings, SK Telecom, South Korea's largest cellular carrier. The company’s shares surged late in the fourth quarter of 2007 on news that the South Korean government would allow the company to engage in a merger with another local telecommunications company, despite antitrust concerns. However, the shares dropped precipitously early this year; the market grew concerned that in order to endear its merger with wary consumer groups, the government was prepared to force SK Telecom to adopt substantial reductions in its tariff schedule. Higher marketing costs and disappointing dividends from the company have also dampened its share price.

Falling markets are always difficult to tolerate. Yet corrections do breed opportunities, and the Fund is always keen to take advantage of such occasions as they arise. The Asian convertible bond market offers an intriguing hunting ground at the moment. For many years, that market was dormant, with a limited number of attractive candidates for investment. However, during the past 24 months, issuance expanded sharply: The market rose from approximately $30 billion in size to $60 billion at the end of 2007. Even as the market grew, however, many of the more recent issues were priced at large premiums, and had no coupons attached. Consequently, such bonds lacked the defensive characteristics that the Fund appreciates. Amidst the broader market correction, these bonds have also declined, and thus new pockets of opportunity have begun to emerge. We look forward to exploring the risks and rewards presented by this market on your behalf.

The views and opinions in this commentary were current as of March 31, 2008. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Funds' future investment intent.

Statements of fact are from sources considered reliable, but neither the Funds nor the Investment Advisor makes any representation or guarantee as to their completeness or accuracy.

As of 3/31/08, HSBC Holdings accounted for 3.0% of the Matthews Asian Growth and Income Fund and SK Telecom accounted for 2.8% of the Fund. The Matthews Asian Growth and Income Fund holds no positions in Bear Stearns.