OREANDA-NEWS. May 25, 2015. After a year in the wilderness, Taiwan equities saw a revival in November after the municipal elections, as the rally in China ignited institutional investor interest in China-related companies.

“Investors looking for North Asia exposure should now consider Taiwan, a market that is unique in Asia in that it is the only one trading at a discount to its five-year history. All other markets trade at a premium,” HSBC wrote in a report.

SGX MSCI Taiwan Futures’ Notional Turnover

Source: Bloomberg

According to the Financial Supervisory Commission, foreign fund flows into Taiwan equity markets reached a record of US\\$203.6 billion as of 4 May. The numbers represent cumulative totals from January 1991 when the government first released foreign institutional funds flow data after lifting its ban on foreign institutions investing in Taiwan's stock market at the end of 1990.

On the back of strong foreign institutional buying, the weighted index on the Taiwan Stock Exchange repeatedly breached the 10,000 point mark on 27 and 28 April before profit-taking set in.

Year-to-date (30 April 2015), the Taiwan Stock Exchange Weighted Index (TWSE) and MSCI Taiwan IndexSM chalked up 5.51% and 5.29% total returns respectively.

Taiwanese equities are starting to offer value versus South Korean equities again, HSBC said in its report.

Taiwan’s benchmark stock index may rally 15% to approach a record this year as earnings prospects and a presidential election in January lure foreign funds, Tony Chen, vice president at Schroder Investment Management (Taiwan), said in a report.

But if the Federal Reserve kick-starts an interest rate hike cycle later this year, a stronger US dollar may prompt foreign institutional investors to move their funds out of the region, which could affect the performance of Taiwan stocks.

Growth Revised Upwards

Taiwan revised its 2015 economic growth target to 3.78 %, highest since 2011, from a preliminary growth estimate of 3.5%, the Directorate General of Budget and Accounting Agency said in a statement on 16 February. The economy expanded 3.5% the previous year.

The island’s trade balance stood at US\\$4.76 billion in April 2015, up from US\\$2.53 billion in January 2014.

Taiwan Trade Balance

Source: Bloomberg

For the moment, Taiwan's top-notch technology companies will benefit from the frenzied demand for Apple’s newest smartphones, as well as the upcoming iWatch. Taiwanese companies produce components that make up the bulk of Apple's iPhones, from semiconductors to camera lenses and home buttons and casings.

Apple, probably the biggest single customer of Taiwan’s tech suppliers, posted record quarterly revenue of US\\$74.6 billion and record quarterly net profit of US\\$18 billion. The company guided for revenue between US\\$52 billion and US\\$55 billion in the second quarter.

What is good for Apple should benefit electronics makers such as Taiwan Semiconductor (“TSMC’) and Hon Hai, which presently account for more than 30% weighting in the MSCI Taiwan IndexSM.

Although Taiwan’s economic data is not as strong as in the late 1990s, it does appear relatively firm compared with its regional peers, said Jefferies in a report.

High correlation between Top 5 ETFs and MSCI Taiwan IndexSM

The top Taiwan ETFs – IShares MSCI Taiwan ETF and Yuanta/P-shrs TW Top 50 ETF – have a combined capitalisation of more than US\\$5 billion as at end of March. Both ETFs demonstrated a weekly correlation of more than 0.70 with the MSCI Taiwan IndexSM over the past year.

Correlation between Taiwan ETFs and MSCI Taiwan IndexSM

Price Performance of Taiwan ETFs and MSCI Taiwan IndexSM

Source: Bloomberg

The iShares MSCI Taiwan ETF tracks the MSCI Taiwan IndexSM , while the Yuanta/P-shrs TW Top 50 ETF attempts to replicate the performance of TSEC Taiwan 50 Index. As the TSEC Taiwan 50 Index shares the top 10 constituents of the MSCI Taiwan IndexSM and their respective weightings,  the correlation is fundamentally sound. In addition, the MSCI Taiwan IndexSM also shares nine of the top 10 constituents of the TAIEX Index.

Taiwan Indices

 

MSCI TAIWAN

  

FTSE TWSE Taiwan 50 Index

   TAIWAN TAIEX INDEX  
Number of Constituents

101

  

50

    836  
Top 10 Holdings

TAIWAN SEMICONDUCTOR

MANUFAC

22.6%

TAIWAN SEMICONDUCTOR

MANUFAC

24.5%

TAIWAN SEMICONDUCTOR

MANUFAC

13.4%
  HON HAI PRECISION INDUSTRY

7.6%

 HON HAI PRECISION INDUSTRY

8.5%

 HON HAI PRECISION INDUSTRY

5.0%
  MEDIATEK INC

3.8%

 MEDIATEK INC

4.4%

 CHUNGHWA TELECOM CO LTD

2.8%
  CATHAY FINANCIAL HOLDING CO

2.6%

 FUBON FINANCIAL HOLDING CO

2.9%

 FORMOSA PETROCHEMICAL CORP

2.5%
  FUBON FINANCIAL HOLDING CO

2.4%

 CATHAY FINANCIAL HOLDING CO

2.8%

 MEDIATEK INC

2.4%
  CHUNGHWA TELECOM CO LTD

2.4%

 NAN YA PLASTICS CORP

2.8%

 CATHAY FINANCIAL HOLDING CO

2.3%
  DELTA ELECTRONICS INC

2.3%

 DELTA ELECTRONICS INC

2.8%

 FUBON FINANCIAL HOLDING CO

2.1%
  NAN YA PLASTICS CORP

2.1%

 CHUNGHWA TELECOM CO LTD

2.7%

 NAN YA PLASTICS CORP

2.0%
  FORMOSA PLASTICS CORP

2.0%

 FORMOSA PLASTICS CORP

2.7%

 FORMOSA PLASTICS CORP

1.7%
  CHINA STEEL CORP

1.9%

 FORMOSA CHEMICALS & FIBRE

2.3%

 DELTA ELECTRONICS INC

1.7%
Top 10 Total Weightings  49.7%    56.6%    35.8%  
Annualised Price Returns            
1-Year 16.0%   17.7%    11.9%  
3-Year 14.1%   14.9%    12.7%  
5-Year 9.4%   10.2%    8.5%  
Monthly Volatility (Standard Deviation)            
1-Year 13.5%   14.1%   11.9%  
3-Year 9.2%   9.3%   8.7%  
5-Year 13.8%    13.8%   13.8%  

Source: Bloomberg (11 May 2015)

As the SGX MSCI Taiwan Index Futures uses the MSCI Taiwan IndexSM as the underlying, it has a strong correlation with the ETFs, which make it suitable as a hedging or trading instrument.

The SGX MSCI Taiwan Index Futures recorded a daily traded notional of  US\\$2.3 billion, out of which 15% is transacted during after-market hours. Trades are at an average bid-offer spread of 2.9 basis points during onshore trading hours, and 3.5 basis points during after-market hours.

The T+1 hours cover a good portion of the ETF trading hours, which makes the contract  an ideal tool for arbitrage or hedging against the cash portfolio.

Settled in US dollars, the SGX MSCI Taiwan Index Futures is a quanto product – a type of derivative in which the underlying is denominated in one currency, but the instrument is settled in another currency at some fixed rate. In other words, this quanto feature removes the FX exposure by settling all profits and losses in US dollars.