Commentary

Quarter Ending September 30, 2008

The Matthews Asia Pacific Equity Income Fund declined –12.30% during the third quarter of 2008, while its benchmark, the MSCI All Country Asia Pacific Index, fell –20.85%. In September, the Fund distributed its third quarterly dividend of 11.43 cents per share, bringing the total year-to-date income distribution to 24.82 cents per share.

Sir John Templeton, an astute contrarian and pioneer of international investing once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” During the past year, global equity markets have gone from a state of euphoria to one of pessimism bordering on depression as we entered into October. During the quarter, the focal point of anxiety in equity markets shifted from global inflationary pressures to the ongoing viability of the global financial system. While the epicenter of the credit crisis and its secondary effects on global economic growth have mainly resided in the U.S. and Europe, shares in Asian companies sold off as risk aversion rose. This was especially true for companies reliant on easy access to credit. However, long-term investors would be well served to pay more attention to the insights of Sir John Templeton than the daily gyrations of the stock ticker. As volatility increases, investors tend to shorten their investment horizon and question the rationale of their investments. However, falling equity markets, while painful in the short term, also represent periods of opportunity, especially for investors who can stomach the volatility and maintain a long-term time horizon.

Today, the investment universe of companies available to the Fund has greatly expanded compared to a year ago. The sell-off has allowed the Fund to consider and purchase shares in companies we deemed to be strong future dividend growers. These companies were previously not attractive due to demanding valuations. Another category of investment opportunity has involved companies that, in our opinion, had experienced selling in excess of fundamentals. This was exemplified by the Fund’s addition of two Japanese real estate investment trusts (REITs), MID REIT and United Urban Investment Corp. The REIT sector in Japan, particularly REITs with a market capitalization of less than $1 billion, had experienced severe selling year-to-date due to concerns of an asset/liability mismatch in the funding of property purchases. In Japan, property acquisitions had mainly been financed with cheap short-term debt, which greatly increased refinancing risk, especially as previously abundant access to credit dried up. However, as a result of falling share prices, the dividend yield had increased to 11.9% and 7.8%, respectively, for the two REITs, representing a wide spread over the local 10-year government bond yield at 1.5%. Furthermore, both REITs had resolved their immediate financing needs and were trading below the value of their property portfolios.

The relative outperformance of the Fund vis-à-vis its benchmark during the first nine months of the year underscores the notion that when it comes to investing in the Asia Pacific region, just as in the U.S., strategy does matter. The Fund’s focus on companies with strong and sustainable cash flows, limited debt levels and growing dividends, offered some resilience even as selling of Asian equities in many cases appeared indiscriminate. Companies with less leverage and strong operational cash flows have less need to tap credit markets, insulating them somewhat from a lack of short-term credit to finance capital expenditures or meet short-term working capital needs. Importantly, it also provides funding for ongoing growth in dividend payments.

The views and opinions in this commentary were current as of September 30, 2008. 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 9/30/08, MID Reit, Inc. accounted for 0.9% of the Matthews Asia Pacific Equity Income Fund, and United Urban Investment Corp. accounted for 0.6% of the Fund.