iShares Taiwan ETF: A Bet on Improved China Relations

Global markets shuddered on Monday, as Asian stocks plunged after the Federal Reserve’s emergency-meeting rate cut and the sale of Bear Stearns (BSC). Taiwan was no exception, with the country’s Taiex index falling almost 2%, bringing it down nearly 8% since March 6.

Prior to the most recent crisis, which saw global stock markets lose $2.4 trillion in market value before Monday’s bout of selling, Taiwan’s markets were in relative rally mode compared to much of the rest of the world.

When trading closed on March 14, iShares MSCI Taiwan Index ETF (EWT) was down 0.8% year to date, still remaining more than 10 percentage points above the MSCI EAFE index. It was also the best performer for one month, three months, and year to date among Pacific ex-Japan ETFs tracked by Morningstar. Through March 14, EWT held a 17.9% year-to-date advantage over the category average and was nearly 12 percentage points better than the next best fund, iShares MSCI Australia (EWA).

EWT has moved swiftly up our ETF Momentum Tracker Sector Momentum Table in recent weeks, jumping from 29th on Feb. 12 to eighth last week.

The ETF tracks its namesake index, a cap-weighted bogey of about 110 holdings that represent nearly 85% of the Taiwanese market. Like Taiwan’s markets, EWT’s 126-stock portfolio is heavy on information technology, with nearly 55% of the fund’s holdings allocated to that sector. Top holding Taiwan Semiconductor (TSM), consumer electronics maker Hon Hai Precision Industry (HNHAF.PK), and LCD screenmaker AU Optronics (AUO) make up 22.7% of the portfolio, sandwiched around the country’s top financial holding company, Cathay Financial, and a few materials companies, including China Steel and two plastics makers.

Taiwan took a nasty beating when the tech bubble burst early in the decade, and it has lagged Asian and emerging markets ever since, in part because the eight year leadership of Chen Shui-bian, whose term will end this week, saw the country pull further and further away from China just as the Asian giant’s economy and markets skyrocketed.

Taiwan’s presidential election will be held on March 22, and Ying-jeou Ma, a pro-business candidate with a more favorable view of China than the current regime has, is expected to win. That’s brought new hope—and new money—to Taiwan’s markets. The MSCI Taiwan index gained 10.4% in February, compared to a 2.7% gain for the MSCI Asia Pacific ex-Japan index, according to The Wall Street Journal.

Taiwanese equity funds recorded inflows for seven straight weeks, according to Massachusetts-based EPFR. Year to date, Taiwanese funds have attracted $636 million, compared to $4.8 billion in outflow from China and Greater China funds, says EPFR.

Last week, the Journal also posited that Taiwanese stocks may be cheap, trading at 16 times reported earnings vs. 19 times for Hong Kong shares and 22 times for overseas-listed China stocks. The Taiwan dollar has been gaining since legislative elections in January and has hit a series of eight-year highs against the weakening U.S. dollar.

The Journal quoted several analysts bullish on Taiwan, including Andrew Foster of Matthews International Capital Management, a San Francisco firm specializing in Asia. “I’ve always seen Taiwan as a peripheral market if you’re trying to invest in the China story,” he said. “And Taiwan clearly hasn’t met its long-term potential in terms of economic development.”

At the moment, many Taiwanese firms—including Cathay and Taiwan Semiconductor—are heavily invested in China, but the Taiwanese government limits what they can do there and essentially bars Chinese investment on the island. Whether Ying-jeou Ma will be able to change that is unknown, but if he does, Taiwanese stocks could benefit.

All that said, EWT carries plenty of risk, as evidenced by a three-year standard deviation of 20.49. The fund’s heavy exposure to single-country risk, highly cyclical chip stocks, and other tech names warrants caution.

Morningstar’s Emiko Kurotsu notes that although Taiwan Semiconductor is the world’s largest chip foundry and AU Optronics holds a 20% global market share, they “have no defensible advantages in fiercely competitive” industries.

He prefers iShares MSCI Emerging Markets and other funds with a stake in Taiwan’s largest companies. Should Taiwan indeed get a bounce from improved relations with China, or from lower valuations after trailing many markets for much of the decade, EWT could be the place to be. The fund holds more than 70% of assets in large- and medium-cap stocks, according to Morningstar, giving it much deeper exposure to Taiwan.

For now, EWT looks like a bet on improved relations between the two countries and on a market that hasn’t kept up with its red-hot neighbors during the long post-2000 rally. There are some signs that’s a possibility, but as the last few months—and even the last week—show, investors shouldn’t expect the ride to be a smooth one.

Comments

[TM]

The recent parliamentary elections in Taiwan provided the China 'friendly' party with a landslide victory; a result which is likely to follow in the March 22nd Presidential elections. Once the new administration takes power they will likely attempt to strengthen ties with China, and Taiwan could begin sharing in China's economic success, from which it has remained mostly isolated. We have bought into EWT a month or two ago and are pleased with the return thus far and think there is a lot of upside. I did a trip to Taiwan recently and the sentiment I got seems to be in general people want whatever it takes to have a stronger economy and more jobs. Bettering ties with China will do this. Right now all trade has to go through a third party between the countries (usually HK). I think if and when direct investment is allowed in Taiwan we will see a strong rally. However, it is important to keep in mind that the 'China Friendly' party isn't running on a platform of reunification, but just on bettering the relationship. Which is a lot better in terms of economic potential than we have seen in the past. Bottom line is I am bullish on the country.

Read more here: fiateconomics.blogspot.com /

[Huangthomas]

Jim Rogers, who live in Singapore now, recommended investment in China through investing in Taiwan. What happened in Taiwan politics during the last ten years is an aberration from norm, provoked by a missile threat from China in 1996, for which President Clinton sent two American carrier groups to Taiwan. Since then, both sides seems to learn to live in peace and prosperity by respecting each others existence.

[John Egan]

The San Francisco Chronicle today had a story that the pro-Mainland party has lost almost 50% of its lead (It is now at a 10% lead -vs- a 20% lead last week) based on issues with Tibet. We have seen how easy it is to drop from front-runner to 2nd place in the Clinton/Obama race here in the U.S. Nothing is over till it is over.. However, having said that many pros are pushing the Taiwan ETF over the FXI for example...

Thx jegan ;-)

[TM]

The news is reporting the opposition party has won the elections.

[Johnc]

The market has outperformed the region YTD in a large part because the KMT (Ma's party) was expected to win. Now that Ma has won, the hard work of rebuilding the economy and restructuring the cross straits relationship begins. I am very positive (and hold EWT) but would warn against anyone expecting a "quick pop". The story will unfold over the next two years. And, when that story does unfold, the front runners will have changed. Taiwan is in the early stages of a transition from a manufacturing led economy to one with a much larger services component. I expect Taiwan's economy to look much more like Hong Kong's or Singapore's than South Korea's in two to three year's time. EWT will participate but may lag behind a better constructed portfolio of Taiwan stocks.