Commentary

Period ended June 30, 2010

For the first half of 2010, the Matthews Asia Science and Technology Fund returned –2.62%, while its benchmark, the MSCI/Matthews Asian Technology Index lost –3.65%. For the quarter ended June 30, the Fund dropped –7.13%, while its benchmark fell –8.27%.

It has been a very volatile period for Asia’s technology sector. During the first quarter, the sector rallied on the back of the ongoing global recovery. However, the sector declined in the second quarter amid concerns over slowing demand for information technology products and rising labor costs in China. The issue of rising wages is not new to the region. China has seen average wage growth of about 15% to 20% over the last few years in technology-related manufacturing jobs, but this year has brought higher-than-average wage growth in China.

This has hurt the region’s electronics manufacturing firms as most of their factories are based in China. One such firm that has been impacted is Hon Hai Precision Industry, which was the worst-performing holding in the Fund during the first half of the year. Despite rising wages, the company is still among the world’s largest and lowest-cost manufacturers of consumer electronics. A leader in its field, Hon Hai began moving its manufacturing base to inland areas of China before most of its competitors, a move which should result in lower labor costs. Hon Hai should be one of the biggest beneficiaries of rising demand for technology products globally.

Not all firms have suffered from China’s rising wages. In fact, some (mostly Japanese) factory automation companies based in Asia have benefited from this trend. Japan has long been a leader in this field as it first automated its factories in the 1980s, and since then has continued to innovate in the area of replacing human labor with machines. Industry experts compare China’s current level of general automation to that of Japan in the 1970s and 1980s. Hence, this may provide growth opportunities for Japanese automation firms over the next decade. Fanuc, one such firm, was among the Fund’s top-performing stocks during the first half of this year. We added Fanuc to the portfolio last year as valuations became very attractive following the global credit crisis. The Fund also added two other factory automation-related companies in the first half of 2010, while decreasing exposure to hardware companies.

Despite reasonable inventory levels during the period, we continued to see some shortages in the area of electronic components in the second quarter, as we did earlier this year. During last year’s economic downturn last year, electronic component makers scaled back on investments, leaving them unprepared when demand recovered quickly at the start of this year. For some component makers these shortages eased during the second quarter. But for manufacturers of LEDs and MLCCs (multilayered ceramic capacitors), which are found in virtually all electronic devices, shortages have continued.

On a country basis, China and India were the biggest contributors to performance during the first half of the year. Technology firms in the Indian market continued to perform very well, and have remained relatively unaffected by macro uncertainties. Their performance continued to climb during the second quarter. Fund performance was helped by our focus on domestically oriented Chinese companies, as improved wages and a potential appreciation in the renminbi have benefited some of these firms.

European sovereign debt issues negatively affected Asia’s technology sector as Europe remains a key source of revenue for many of the region’s technology companies. The uncertain outlook and weak euro contributed to the market’s decline in the second quarter. Europe’s troubles, coupled with the potential for a slowdown in the global recovery, remain key risks for Asia’s technology industries in the second half of the year. Despite these short-term challenges, we continue to focus on long-term growth opportunities. Not only is Asia the largest manufacturer of personal computers and mobile phones—key growth drivers for the global technology sector—but the region has become the largest market for these products, surpassing Western Europe and the U.S. Furthermore, the overall penetration rate of technology products in key Asian markets, mainly China and India, remains relatively low. As discretionary income levels rise in the region so should expenditure on technology products.

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 Science and Technology Fund in the following percentages: Hon Hai Precision Industry Co., Ltd. represented 2.1% of the Fund. Fanuc, Ltd. 2.1%.

* To better reflect its investment strategy, the Fund’s name changed from Matthews Asian Technology Fund to Matthews Asia Science and Technology Fund on April 30, 2010.