Investing in Taiwan: Choosing The Taiwan Fund Over iShares' ETF

Includes: EWT, TSM, TWN
by: David Urban

Taiwan is heading for a tumultuous period ahead. The DPP and KMT are prepared to go head to head once again next year for the right to follow current president Chen Shui-bian. Over the past 4 years, Chen's reign has been dogged by allegations of corruption in which family members have been found guilty of embezzlement and Chen's wife is currently on trial. In fact, earlier this year when Chen started his anti-China rhetoric forcing Taiwanese businesses to remove the word China from their names it was merely an attempt to steer the press away from the constant coverage of his wife's embezzlement trial.

Currently, Chen has tabbed Frank Hseih as his heir apparent and he will face KMT nominee Ma Ying-jeou in an election next year.

The DPP has spent the past few months attempting to remake itself into a pro-China party with similar views to KMT.

The business community has largely become despondent. Firms are delisting in Taiwan and relisting in Hong Kong to avoid the restrictions on Chinese investment in Taiwan. Taiwanese firms remaining in Taiwan cannot wait for the election to arrive as they believe that a change is in order.

Valuations reflect the depressed nature of the business community and a lack of local investor participation. Foreigners have been buying the market ahead of the election hoping for a change in leadership to a more pro-business government.

Most Taiwanese firms do not have liquid ADR programs, so an investors' most liquid bet is to play either the iShares Taiwan (NYSEARCA:EWT) or the closed ended Taiwan Fund (NYSE:TWN). Our preference is for the closed ended Taiwan Fund, currently selling for a 10% discount to the market. The composition of the portfolio is more diversified than the iShares, in which TSMC and Hon Hai counts for more than 20% of the total portfolio.

I am adding the Taiwan Fund to my portfolio with a target price placed $0.01 above the NAV, as I expect the discount to close sometime before the election.

An interesting play to mirror the iShares fund would be to purchase your allotment of the Taiwan Fund and then buy TSMC ADR's (NYSE:TSM) up to the level held in the iShares fund. It is a rough way of replicating the portfolio while playing the discount at the same time.

One final note, with the recent sharp rise in the Taiwan and Thailand stock markets, we are going on a black swan alert as it appears as though the chances for a disruptive external event are high. Within Asian markets, Japan tends to lead regional rallies, with Thailand and Taiwan being laggards. When they rally it is usually a sign that a top is being put in place. No telling where, or when the black swan will occur, as they never give warnings but, as an investor you should be on guard.

Disclosure: The author is long TWN.