Commentary

Period ended June 30, 2010

For the first half of the year, the Matthews Asia Small Companies Fund gained 3.29%, outperforming its benchmark, the MSCI All Country Asia ex Japan Small Cap Index, which lost –1.91%. For the quarter ended June 30, the Fund declined –1.69%, while its benchmark fell –5.98%.

Concerns surrounding Europe’s sovereign debt issues continued to affect global sentiment in the second quarter of the year. The sharp depreciation of the euro against the U.S. dollar in May, coupled with sell-offs in global equity markets, exacerbated fears of a repeat of the global financial crisis we witnessed not long ago. The likelihood of a global economic recovery appeared more fragile than previously expected. Asian equities were not immune to severe sell-offs as investors showed concern for real financial impacts, not just investor sentiment. Europe is one of China’s largest export markets. Dampened demand and eroding purchasing power in Europe could present huge challenges to its export sector. At the corporate level, company earnings could also fluctuate depending on end-market demand.

External factors aside, Asia is faced with other macroeconomic issues that are mostly inflationary. With property prices rising considerably across many cities in China, the government introduced several tightening measures in attempts to cool down the property sector. On the labor front, intense pressure from factory workers demanding increased wages has driven salaries higher in several high profile cases.

In general, however, Asia’s economic growth has recovered from recent lows, prompting central banks to evaluate the resurgence of inflationary pressures. In fact, India, Malaysia and Taiwan all raised interest rates in the second quarter. China announced plans to reform its exchange rate regime to increase flexibility, sparking some short-term excitement in the market during the same period.

Amid a rather uncertain market environment, the Fund stayed consistent with its strategy of focusing on domestically oriented and high quality companies. Stock selection accounted for the bulk of the Fund’s outperformance over its benchmark in both the first and second quarter of 2010. We are pleased that companies with solid fundamentals that made shrewd business decisions to grow and expand were recognized by the market. The Fund’s holding in materials, consumer staples and health care were the top contributors. Information technology stocks, however, were the largest detractors. In addition, our long-standing overweight in India and underweight in Taiwan favorably impacted the Fund’s performance.

On a company basis, Korean materials firm POSCO Chemtech was a major contributor to Fund performance in the first half of 2010. The company supplies refractory material and maintenance services to steel manufacturers in Korea. While steel manufacturing itself can be a cyclical and capital-intensive industry, POSCO Chemtech’s earnings profile has been steady thanks to the consumable and recurring nature of its products and services. The company also spearheaded a new chemical division that will provide it with additional diversification. Going forward, POSCO Chemtech’s earnings momentum is expected to be robust on the back of increasing steel production capacity in Korea as well as its expanded product offerings.

Toward the end of the first quarter of 2010, the Fund initiated a small position in Jyothy Laboratories, a consumer staples company in India. Jyothy’s product portfolio includes fabric care, dish washing detergents and household pesticides. Most recently, the company launched a mosquito repellant product, which is expected to do well in rural areas. After seeing strong organic growth in its existing product lineup and a promising new product launch, we increased our position in the company. In the second quarter, Jyothy was a substantial contributor to Fund performance.

Unfortunately, not all of our holdings performed as well as we hoped. Asiatravel.com Holdings, an online hotel and travel booking service provider based in Singapore, performed poorly. The company suffered some slowdown in travel booking due to poor global sentiment, as well as a sharp drop in visitors to Thailand following a sudden escalation of political unrest there in April. However, we believe that these setbacks are largely temporary in nature. The company is a leader in its space in Southeast Asia and we believe its technology platform and products are desirable in the long run given Asia’s demographics and spending trends.

As the global macroeconomic picture remains somewhat murky and a “double-dip” recession scenario has become a popular topic of debate among investors, we remain focused and cautious regarding potential risks to our holdings. While the market has undoubtedly become more volatile, we were encouraged to see that some quality companies managed to thrive in their respective industries. We will continue our bottom-up investment selection efforts. We believe that valuations remain reasonable in Asia and should present attractive opportunities for long-term investors.

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, the securities mentioned comprised the Matthews Asia Small Companies Fund in the following percentages: POSCO Chemtech Co., Ltd. represented 1.8% of the Fund. Jyothy Laboratories, Ltd. 1.9% and Asiatravel.com Holdings, Ltd. 1.0%.