Fund name: Matthews Asian Growth and Income (MACSX)

Objective: Long-term capital appreciation and "some current income." With a trailing twelve-month yield of 4.91%, it exactly matches the payout on Vanguard’s Total Bond Market Index (VBMFX), which sure looks like it generates rather more than "some" income. The fund invests primarily in dividend-paying equity securities and convertible securities, of any duration or quality, of companies located in Asia, which includes China, Hong Kong, India, Indonesia, Japan, Malaysia, Pakistan, Philippines, Singapore, South Korea, Taiwan, Thailand and Vietnam. All of the Matthews’ managers tend toward a growth-at-a-reasonable-price bias in security selection.

Adviser: Matthews International Capital Management. Matthews was founded in 1991 and has about $9 billion in assets in its eight other Asian funds. A ninth fund, Asian Small Companies, will launch in September 2008. They have 20 investment professionals on staff and have recently added folks with expertise in India, small caps, and Japan. They’ve also hired a new Director of Research to succeed Andrew Foster (see below) in that role. On whole, the Matthews funds offer below average expenses. With the exception of the Korea fund, the group has below-average risk in Morningstar’s rating system and generally average-to- high returns. They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Managers: Andrew Foster is the lead manager and has been working with the fund since 2005. Mr. Foster is also Matthews’ acting CIO, the lead manager on the India fund, and co-manager of the Asia Pacific Equity Income and China funds. He has been with Matthews since 1998, except for a short break to complete his MBA at INSEAD in France. Mr. Matthews, the firm’s founder, serves as co-manager.

Management’s Stake in the Fund: Mr. Foster and Mr. Matthews are each invested in each of Matthews’ nine funds. As of the last SAI, Mr. Foster has between $50,001 - $100,000 here while Mr. Matthews has between $100,001 - $500,000. In addition, each has an ownership stake in the advisor.

Inception: September 12, 1994.

Minimum investment: $2500 for regular accounts, $500 for IRAs.

Expense ratio: 1.15% on an asset base of around $1.9 billion. There’s also a 2% redemption on sales of shares held fewer than 90 days.

Comments: The folks at Matthews International decided to re-open this fund to new investors on September 2, 2008. Public data suggests that the fund has seen something like $100 million in redemptions this year. If you look just at the fund’s performance relative to its peer group, you might agree that it’s a poor option. The fund has posted three- and five-year returns in the bottom 20% of all Asia-focused funds. Morningstar’s "data interpreter," which mechanically assigns text to a fund’s statistical profile, offers this bottom line analysis: "This fund's record isn't very encouraging."

All of which I’d characterize as utterly slack-witted drivel.

The Asian market is incredibly volatile. Oberweis China Opportunity, for example, returned 80% in 2006, 60% in 2007 and has lost 40% so far in 2008. T. Rowe Price’s New Asia fund was, over the same period, up 36%, up 66% then down 38%. It’s no surprise that an individual fund’s assets might easily rise or fall by 50% in any given year, as alternately greedy and fearful investors charge in and out of the door.

The folks at Matthews International strove to create a fund which might "discover investments that trace the evolution of Asia’s markets yet offer some downside protection even amidst volatility." They designed structural characteristics that would substantially dampen the fund’s volatility, in hopes that would give investors the courage to hang on for the long term and reap some of the substantial returns the region has to offer. Matthews Asian Growth and Income is that fund. It started in 1994 with a focus on convertible securities, which are bonds which can, under preestablished conditions, be exchanged for shares of common stock. When the stock market is bad, the bonds reduce volatility and generate valuable income. When the stock market rises, the bonds can be converted into common stock which will capture some of the market’s upside. Over time, the portfolio evolved away from an exclusive focus on convertibles to include dividend-paying common stocks, preferred shares, and both US and locally-denominated bonds.

The fund’s size increased 500% in 2003. The managers concluded that they couldn’t afford to accept additional investments because the growth of their assets was outstripping the growth in the Asian convertible securities market. So, they closed the fund.

The conditions which led to that closure have now changed. First, the Asian convertibles market has grown from about $20 billion back when the fund closed to about $50-55 billion in late 2008. In addition, there’s an increasingly robust market in other income-producing securities. Second, the sharp decline in the Asian markets means that a lot of securities – including, according to Mr. Foster, convertible securities which were a year ago priced too richly – are now selling a substantial discounts to their fair value. Finally, data reported at Morningstar shows that the fund is seeing asset outflows. That puts the managers in a bad position: the only way to upgrade the quality of the fund’s portfolio – that is, to acquire the securities selling at the most compelling valuations – is to sell other parts of the portfolio. Since they have very few losing positions, they’re being forced to sell profitable positions whose best days are behind them. And that’s not tax-efficient.

Mr. Foster believes that the portfolio "is healthier now" than when the fund closed in 2003 and that investors "should be excited" about its prospects. He’s right. (He’s also gracious: Mr. Foster took time away from a family vacation to chat with me about the fund. That was a really considerate gesture for which I’m grateful.) If you feel like being excited about the fund, here are some reasons to do so:

• It is, by far, the least volatile Asian fund in existence. MACSX has a standard deviation – a measure of how much returns bounce from year to year -- of 11.2%. The only fund even close to that restricts itself to Australia and New Zealand. The Asian group as a whole averages 23.5%. Lipper makes it a "Lipper Leader" in capital preservation for every period they measure.



• It has been one of the most consistent performers among all international funds. TheStreet.com ran an article in late 2007 which identified all of the stock funds with 10 consecutive years in the black. There were only twelve (including conservative balanced funds) and only two were international: MACSX and Jean-Marie Eveillard’s splendid First Eagle Overseas.



• The fund has outstanding absolute returns. It earned 12% over the past three years, 16.5% over the last five and 18.9% over the decade.



• The fund does not surrender much upside. In its worst relative-performance years – that is, the years when it trails more than 75% of its peers – the fund returned an average of 33% per year.



• Finally, the fund’s management is extremely shareholder friendly. It has the 5th lowest expense ratio among the 43 retail Asian funds. Portfolio turnover, 28%, is less than one-third of the group’s average. And, obviously, the management is willing to close the fund when they think its size threatens its shareholders’ best interests.

Bottom line: Matthews Asian Growth and Income is a splendid fund and has some prospect of becoming even better. As the Asian fixed-income and convertible securities markets develop, the managers will be able to choose from a more-diverse array of tools with which to build a carefully risk-managed portfolio. It’s one of the most compelling options for investors who want exposure to Asia’s vibrant economies and who are willing to surrender a fraction of the region’s upside in exchange for avoiding the majority of its downside.