Commentary

Quarter Ending June 30, 2008

The Matthews Asia Pacific Equity Income Fund declined –4.66% during the first six months of 2008, while its benchmark, the MSCI All Country Asia Pacific Index, fell –12.18%. During the quarter ending June 30, 2008, the Fund distributed its second quarterly dividend of 7.53 cents, bringing the total year-to-date income distribution to 13.39 cents per share.

Inflation fears, driven by rising oil and food prices, as well as worries about the impact of a potential U.S. recession on corporate profits in Asia, weighed on equities across the region. Equity markets in Asia Pacific continued to exhibit a high degree of correlation with global markets. However, a short-term singular focus on the correlation in equity markets misses the point that when it comes to dividend payments, Asian companies move to a different beat than their U.S. counterparts. The balance sheets of companies in the region generally remain as healthy as they have been during the past decade, while earnings growth has continued to support dividend payments. This is important for long-term investors since sustainable and growing dividends can help mitigate some downside volatility during periods of pull-backs in equity markets. The Fund’s relative outperformance for the period may, in part, be reflective of this. For dividends to offer support to share prices though, they must at a minimum be “sustainable.” Once the dividend is cut or market participants suspect it cannot be maintained, share prices tend to suffer as a consequence. The financial sector in the U.S. during the past 12 months has shown evidence of this.

The Fund seeks to invest in companies we believe will grow dividends over time. Dividends may not always grow in a straight line from year to year and in some cases, may even be cut. This holds particularly true for smaller companies, with more volatile earnings, less access to capital markets and therefore, a greater need to maintain capital on the balance sheet. The attraction of successful smaller companies, though, is their potential to grow the dividend at a faster rate over the longer term. To mitigate the risk of dividend cuts, the Fund is diversified across 51 companies along the market capitalization spectrum, residing in 12 countries and operating in 9 different economic sectors. While five of the Fund’s portfolio holdings cut dividends during the last fiscal year, as of the end of June, 36 raised dividends, resulting in a weighted 13% increase in the dividend per share at the portfolio level. The companies that cut their dividends were of small or medium capitalization.

Lawson Inc., Japan’s second-largest convenience store operator with more than 8,500 stores, was the Fund’s primary contributor to performance during the first six months of 2008. Japan has for years been a challenging environment for retailers. Deflationary pressures made it difficult for retailers to increase prices and general spending was subdued due to stagnant wage growth. Retailers generally benefit from a moderate level of inflation since it allows them to pass through price increases that, in turn, underpin same-store sales growth. Furthermore, the convenience store segment in Japan has become increasingly competitive as the main convenience store operators have pursued aggressive store roll-outs. Even given these challenges, Lawson Inc., a holding since the Fund’s inception, has performed well operationally. While same-store sales had experienced protracted declines in recent years, the company still managed to grow cash flows and dividends. The company has been at the forefront in Japan when it comes to capital management. Lawson's estimated dividend payment for the current fiscal year represents an increase of 45% compared to the previous year. The company is also engaging in share buybacks in order to improve capital efficiency. Furthermore, should inflation take root in Japan, Lawson Inc., could be a primary beneficiary.

The Fund’s Indian holdings were the main detractors to Fund performance as foreign portfolio flows continued to exit the country. With wholesale inflation accelerating from 3.8% at the end of 2007 to 11.9% at the end of June, investors expect the Reserve Bank of India (RBI) to become increasingly assertive in its stance toward inflation. The RBI has already twice raised the repurchase rate, increasing it from 7.75% to 8.50% during the month of June. The higher credit costs mixed with a hike in fuel prices represented two strong headwinds for Ashok Leyland, India’s second-largest commercial vehicle manufacturer, making it the Fund’s main detractor to performance during the first six months.

The Fund continues to invest in companies we believe can sustain or grow their dividends, even during periods of rising cost pressures. We continue to find attractive investment candidates, especially in companies that enjoy a strong market position. This standing can derive from brand power or from dominant market share within their respective industries. These companies retain a greater ability to pass through costs via higher prices, thereby maintaining margins and the cash flows to fund dividend payments.

The views and opinions in this commentary were current as of June 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 6/30/08, Lawson Inc. accounted for 3.7% of the Matthews Asia Pacific Equity Income Fund and Ashok Leyland accounted for 1.2% of the Fund.