China has begun a long-term transformation of its health care industry. Much of this industry is still fragmented and in the early stages of consolidation. China’s top 10 pharmaceutical companies, for example, account for a combined market share of approximately 20% versus more than 60% in the U.S. Similarly, its top three drug distributors also account for a combined market share of approximately 20% in China versus nearly 100% in the U.S. Based on what I observed from my last research trip to China, I believe that one of the key differentiating factors for companies that endure is a company’s access to capital.

Amid this wave of consolidation, many Chinese health care companies are trying to grow as quickly as possible in the race to become industry leaders. Often, their strategies include aggressively entering new markets and investing ahead of the growth curve. The effort typically requires an enormous amount of capital and targets growth rates well above that of their underlying markets. As a result, larger companies with more resources may strengthen their competitive positions over time while smaller companies, more lacking in resources, may exit the industry or be acquired.

China's major pharmaceutical companies, for example, are intensely focused on growing product pipelines, laying foundations for future revenue growth. To do so, they are investing in internal R&D, in-licensing drugs from outside of China and strategically engaging in merger and acquisition activities. Furthermore, in anticipation of a growing product pipeline, these pharmaceutical companies are investing in their infrastructure and capabilities, especially in terms of deepening their geographic reach. For instance, several firms I met with recently in China are seeking to capture the growth potential in the country’s smaller (third- and fourth-tier) cities where competition is relatively limited and the policy environment is more favorable than in China’s larger cities. Consequently, larger pharmaceutical companies with more resources and better access to capital may be poised to widen their leading positions over time.

On the other hand, smaller pharmaceutical companies are struggling to stay competitive. Recently, sterile drug manufacturers in China were asked to comply with new manufacturing regulations, an effort that required a significant amount of capital to build new factories or retrofit existing ones. Just nearly 800 of the more than 1,300 drug manufacturers were able to meet the deadline. The remaining 40%, mostly smaller firms, will face shut down, consolidation or other strategic alternatives.

Obviously, a company’s ability to access capital is important when internally generated cash flow is not enough. The equity market, among the key sources of capital, can be tapped to a limited extent. China’s debt capital market is still in its infancy. Finally, remaining sources of capital come from banks, which currently offer only limited medium- to long-term products that match the duration for which the capital is used. Therefore, I believe companies with strong funding profiles stand to emerge as leaders in this evolving industry.

You should consider the investment objectives, risks, charges and expenses of the Matthews Asia Funds carefully before making an investment decision. This and other information about the Funds is contained in the prospectus or summary prospectus which may also be obtained by calling 800.789.ASIA (2742). Please read the prospectus carefully before you invest or send money as it explains the risks associated with investing in international and emerging markets. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. In addition, single-country and sector funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific industry, sector or geographic location. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.

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