Commentary

Period ended June 30, 2010

For the first half of 2010, the Matthews Asia Dividend Fund gained 4.82%, outperforming its benchmark, the MSCI All Country Asia Pacific Index, which declined –5.18%. For the quarter ended June 30, the Fund fell –4.27% and the benchmark declined –9.35%. In June, the Fund distributed 7.96 cents per share, bringing its total year-to-date income distribution to 13.36 cents per share.

The second quarter proved to be yet another roller coaster for investors. During the first quarter, the economies of the developed world were perceived to be on the mend with Asian economies continuing to post strong economic data. However, worries over sovereign risk came to the fore as questions were raised regarding the sustainability of debt levels of some European Union countries. As the second quarter came to a close, markets had forgotten about previous indications of recovery, and instead began pricing in the risk of a double-dip recession in developed economies and a “hard landing” in China. Asia was not immune to the fallout from Europe as equity markets declined globally and some currencies, such as Korea’s won, weakened. Some portfolio holdings with exposure to Europe were particularly weak in the second quarter—most notably, Hong Kong-based fashion retailer Esprit Holdings, which derives 85% of its sales from Europe. The position was added to the portfolio late last year after the company took full ownership of its joint venture in China, making Asia a greater focus for the company going forward.

Japanese companies continue to be the main contributor to Fund performance year-to-date, supported in part by the 5.2% appreciation of Japan’s yen. Our all-capitalization investment approach helped performance during the first six months of 2010 as companies with market capitalizations under US$5 billion were the main contributors to performance. We continue to allocate to small- and mid-sized companies to enhance the Fund’s overall dividend growth profile. Portfolio holdings were consolidated as more attractive replacements were found for positions that had experienced strong appreciation since our initial investment. At the end of June, the Fund had 60 holdings compared to 66 at the end of March. During the second quarter, real estate asset manager, ARA Asset Management, with US$10.4 billion under management, was added to the Fund. We have long followed the evolution of Asia Pacific’s real estate investment trust (REIT) market, but, to date, participated as investors only in listed REITs across the region. ARA Asset Management derives its earnings from the management fee paid by investors in its REITs and private funds. The company’s private funds have attracted high-profile international investors. The company is predominantly compensated based on the book value of the real estate under management. We believe ARA should benefit from the ongoing expansion of both listed and privately held real estate investment vehicles in Asia, making the company a good supplement to the Fund’s REIT holdings.

The main factor behind the lower dividend distribution for the Fund year-to-date, compared to the same period last year, was mainly due to higher equity valuations. The Fund’s investment objective is total return, of which, dividends constitute one essential component alongside capital appreciation. Since the inception of the Fund, approximately one-third of the total return has been derived from dividends, with the remainder from capital appreciation. The benefit of being a dividend-focused investor is not only the tangible benefit of the dividends received. The ability to pay consistent and growing dividends often signals companies that exhibit solid market positions, sustainable business models and better management teams. Dividend payments can indicate to minority investors that the earnings generated are real since money has to be earned before it can be paid out. From a corporate governance standpoint, minority investors have greater assurance that they will partake fully in the growth of such companies since they are paid in accordance with their ownership, thereby lowering the risk of cash being siphoned off by majority shareholders. While our investment strategy and method of identifying attractive companies remain unchanged, the dividend yields available today have compressed compared to a year ago.

Market gyrations often prompt investors into a short-term mode of trying to time the markets. This often means trading based on the “noise” of the market instead of on the longer-term fundamentals. For those who can look beyond the noise, Asian companies continue to offer long-term investors the potential for dividend growth at attractive yields.

There is no guarantee that a company will pay or continue to increase dividends.

The views and opinions in this commentary were current as of June 30, 2010. 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 6/30/2010, Esprit Holdings, Ltd. represented 1.5% of the Matthews Asia Dividend Fund, and ARA Asset Management, Ltd. represented 1.2%.

* To better reflect its investment strategy, the Fund’s name changed from Matthews Asia Pacific Equity Income Fund to Matthews Asia Dividend Fund on November 30, 2009.