Commentary

Quarter ended March 31, 2009

For the quarter ended March 31, 2009, the Matthews India Fund returned -11.35% underperforming its benchmark, the Bombay Stock Exchange (BSE) 100 Index, which returned -4.79%. The Indian equity markets were rife with speculation and false rumors in the aftermath of one of the worst corporate scandals in India’s recent history. As a result, some of the mid-sized companies in the portfolios suffered and have yet to fully recover. Furthermore, the withdrawal of foreign institutional investors (FII’s) from India’s capital markets early in the quarter exaggerated the impact on smaller and mid-sized companies such that the BSE Small-Cap and BSE Mid-Cap Indices posted returns of -15.3% and -12.2%, respectively.

From its inception, the Matthews India Fund has placed significant emphasis on indentifying those entrepreneurs that we feel are capable of building robust business models to take advantage of the long-term growth opportunities in India. Our conviction and investment thesis surrounding several of these companies were tested in the current environment. With the exception of one instance where we exited a position due to funding risks, we remain confident about our investments and believe that the current crisis will provide some invaluable lessons for Indian companies. One of the Fund’s largest pharmaceutical holdings, Glenmark Pharmaceuticals, is learning the hard way to focus on cash flow and not just growth, and to manage investor perception about the company’s long-term outlook. The sharp decline in Glenmark’s share price in January was partly a reflection of a strained balance sheet, but more a consequence of the skittish environment surrounding mid caps in India. At these levels, Glenmark looked attractive and we added to our existing position.

Glenmark’s challenges underscore a key problem facing Indian companies—volatility in capital flows becomes exaggerated when risk aversion rises globally. The issue will be compounded if foreign investors continue to depart from India’s capital markets. Regulators are moving quickly to contain the fallout and improve the governance structure employed by Indian companies. Some important changes have already been initiated. In particular, the Securities and Exchange Board of India (SEBI) has mandated that every time a promoter pledges company shares as collateral, a disclosure must be made regarding the details of the transaction. SEBI has also tightened the norms surrounding the declaration of dividends, and is requiring more upfront money before warrants can be issued.

While the macro environment remained difficult, there were some early signs of stabilization. For example, during the quarter we saw an increase in the willingness of banks to start lending, albeit gradually. This change is providing some support to sectors like automobiles and real estate. Nonetheless, the risks to corporate earnings remain, and upcoming elections in April may cause some uncertainty among investors. In spite of a bit of recovery in stock prices late in the quarter, valuations remain attractive in our view, particularly for smaller and mid-sized companies. Our stance has been reinforced as these companies have announced an increasing number of share repurchases, and we have seen a pickup in insider buying. The focus of the portfolio is to take advantage of the recent sell-off, and maintain a significant presence among sectors like financials and industrials, both of which are vital to the long-term development of India’s economy.

The views and opinions in this commentary were current as of March 31, 2009. 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 3/31/2009, the security mentioned comprised the Matthews India Fund in the following percentage: Glenmark Pharmaceuticals, Ltd. represented 2.8% of the Fund.