Investing In Taiwan: One ETF And Three Stocks To Know

Includes: EWT, UMC
by: Nicholas Vardy, CFA

Taiwan is the world's political orphan. Although it has been independent for half a century since the end of a civil war with China in 1949, only 24 countries in the world even recognize its existence. Its politics are dominated by its relationship with China -- which is like a bickering, unwanted stepmother constantly seeking custody of Taiwan, its annoyingly successful but errant stepchild.

U.S. investors who are less schooled in Asian history can be forgiven for viewing Taiwan as the Asian outpost of NASDAQ. Because of its high concentration in technology, the Taiwanese stock market has tracked the U.S. high tech market almost uncannily since the collapse of the tech bubble.

Indeed, the iShares Taiwan ETF (NYSEARCA:EWT) -- unlike in most emerging markets -- is dominated by the technology sector, with a 25% weighting in semi-conductors, 17% in electronic equipments, and 14% in computer and peripherals. The Taiwanese stock market lives and dies with technology.

Investing in Taiwan: Historical Primer
In many ways, Taiwan is the success story that mainland China could have been -- absent the millstone of Communism. While most resource-rich countries like Brazil and Russia pump finite natural resources out of the ground to fill their coffers, Taiwan accumulated its breathtaking $265 billion in foreign currency reserves -- the third highest in the world -- the old fashioned way. Taiwan earned it. Had mainland China (population: 1.3 billion) been as efficient as tiny Taiwan (population: 23 million) in hoarding dollar reserves, China's reserves would stand at $15.6 trillion -- more than the GDP of the entire U.S. economy.

Taiwan's secret? A large chunk of the one million Chang Kai Shek supporters who fled to Taiwan in 1949 were bourgeois Chinese -- governing elites, merchants, Chinese capitalists, and well-educated professionals. American aid -- which constituted more than 30% of domestic investment throughout the 1950s and early 1960s -- helped, too. Although the U.S. never established diplomatic ties with Taiwan, American-inspired land reform, aid and investment. Free universal education helped bring the Taiwanese economy into the 20th century. And, hats off to the Taiwanese people for taking the ball and running with it. Turns out Taiwan's secret to success is no secret at all: hard work, a market economy, and a little help from the U.S. Voila, in 50 years, Taipei boasts the world's tallest building and Taiwan's high tech industry rivals Silicon Valley.

Investing in Taiwan: High Stakes Political Posturing

Since China has never renounced its right to "reunify" Taiwan, Chinese military action hangs like a sword of Damocles over Taiwan's head. More than 700 Chinese missiles are aimed at Taiwan. Just last year, China's legislature passed an anti-secession law authorizing military action against Taiwan if it moves toward independence. Truth be told, like a recalcitrant teenager, the Taiwanese government enjoys tweaking its nose at its stepparent across the strait. Just last week, five Taiwanese state-owned companies dropped references to "China" from their names -- another snub to the mainland in this high stakes game of political tiddlywinks. A bigger worry for Chinese leaders is that Taiwan may change Taiwan's official name from the "Republic of China -- or even declare independence.

Taiwan's opposition party, the KMT, embraces a different approach to cross-strait ties, advocating a free-trade agreement and eventually a full-fledged common market with the mainland. More likely in the years ahead is a kind of "detente by default" -- agreements on smaller issues like tourism, gradually helping to build up mutual political confidence.

Trumped by the Benefits of Business

Talk to businessmen, and the political posturing between Beijing and Taipei seems both incongruous and anachronistic. For two sworn political enemies, economically Taiwan and China could hardly be closer. China is Taipei's number one export market, with nearly 40% of Taiwan's exports going to China. The mainland has attracted more than two-thirds of Taiwan's foreign investment. More than 70,000 Taiwanese firms have set up on the mainland and Taiwanese companies employ some 10 million people in China. Over 300,000 Taiwanese businessmen and their dependents now live in the greater Shanghai area.

Indeed, it seems that business and politics almost exist in parallel, non-overlapping universes. There is good reason for neither party to upset the apple cart. China has Taiwanese investment to thank for turning the Chinese mainland into a global leader in information-technology [IT] equipment assembly -- and for overtaking Japan and Taiwan to become the world's second-largest IT hardware producer after the U.S. Indeed, electronic and IT products accounted for nearly one-third of China's total exports. The list of China's top 200 export companies is headed by subsidiaries of Taiwanese IT firms. It turns out that more than 60% of these exports are made in China by Taiwanese companies. So the next time you see "Made in China" on your new computer, realize that the profits are probably going into capitalist Taiwanese coffers.

Investing in Taiwan: Asia's NASDAQ

If Taiwan's alter ego in high tech manufacturing is mainland China, in the financial world, that alter ego is the high tech dominated NASDAQ. Taiwan was as negatively affected by the collapse of the tech bubble as was Silicon Valley. In the post bubble year of 2001, Taiwan's economy contracted by 2.2% -- the first whole year of negative growth in half a century.

But like Silicon Valley, high tech Taiwan is back. Taiwan Semiconductor Manufacturing (TSMC) and United Microelectronics (NYSE:UMC) -- two Taiwanese tech giants -- together account for around 70% of the world's foundry production. They also symbolize Taiwan's transformation from a maker of cereal box prizes 25 years ago to a manufacturer at the cutting edge of high technology. That alone should make the citizens of Taiwan -- the world's political orphans -- proud.