Time for Taiwan ETFs?

Zacks ETF Research

The global economy is in the doldrums. A dismal U.S. job scenario and threats of political turmoil in Greece have put equity returns at risk, not only in the short term but over the rest of 2012 as well. Thanks to this, investors are looking to other, often overlooked markets for better opportunities to invest where the growth potential is higher.  

Taiwan, one of the emerging economies of Asia, might be a good play at present for investors seeking to follow this strategy (read: Three Overlooked Emerging Market ETFs). The TWSE Taiwan 50 Index considered so far as the benchmark has gained more than 4% year-to-date which is a solid performance considering the weakness in other developed markets around the globe.

This surge in price has been supported by increased volume, suggesting that investors are beginning to take another look at the market for their allocations. In fact, in a recent study by Business Environment Risk Intelligence (BERI), Taiwan has emerged as the world’s fourth best place to invest behind Singapore, Switzerland, and Norway. (Read: Time to Buy the Singapore ETFs)

It also doesn’t hurt that Taiwan has a relatively established equity market and financial system. The economy grew at an average rate of 4.04% last year but is expected to slow down to 3.6% this year due to the lingering global economic conditions.

However, many forecast this to just be a temporary drop as the economy will, according to the IMF, rebound to 4.7% growth next year. Meanwhile, inflation remains below 1.5% while interest rates are also low—but not extreme—at 1.875%, suggesting that the country still has policy tools at its disposal.

Domestic consumption and foreign inflows (exports) are the key contributors to the economic development in Taiwan. Lower interest rates are boosting domestic demand while the country’s foreign trade is picking up with healthy levels of exports and imports. In particular, Taiwan is a major exporter of machinery and electronic products, while it is a key importer of agricultural and industrial raw materials.

However, due to the small size of the country, it is relatively dependent on exports to power growth as opposed to domestic consumption. Currently, the Taiwanese economy is largely dependent on the economies of Japan, China and the U.S. for exports.

Yet investors should also note that China (including Hong Kong) is the largest trading partner of Taiwan. On one side, the cross-strait relations between China and Taiwan are strengthening as they are in the process of relaxing certain trade and investment restrictions. Once liberalized, this would provide Taiwan access to China’s huge market (Read: What Bubble? China ETFs Soaring To Start 2012).

On the other, there are ongoing tensions with the mainland as Beijing views Taiwan as a ‘rebel province’ that must eventually be brought under control. Additionally, China has over 2,000 missiles aimed at the small island nation, always keeping the possibility of military tension on the backburner.  

Beyond these issues, Taiwan’s future economic and business prospects seem promising, especially if investors look beyond the current woes facing the broad global economy. The nation remains a technological powerhouse and is quite developed compared to many other nations in the region. Thanks to this, the country could be a solid performer for years to come.

For investors intrigued by these trends, a look at some of the ETFs targeting the market could be a good way to play the space. Currently, investors have two options for Taiwan ETFs, each of which we have outlined below: (See more ETFs in the Zacks ETF Center)

 MSCI Taiwan Index Fund (EWT)

This fund, issued by iShares in June 2000, provides broad exposure to the Taiwanese equity market. It is a passively managed fund and seeks to replicate the MSCI Taiwan Index, holding 116 securities in total.

With AUM of about $2.3 billion, the product is heavily exposed to the information technology sector followed by financial and materials. (Read: Three Great Tech ETFs That Avoid Apple) From an individual security perspective, the fund allocates a large part to the top 10 firms with a share of around 46% going to this group. The top three holdings include Taiwan Semiconductor Manufacturing, Hon Hai Precision, and Chunghwa Telecom.

While giant and large companies hold more than 80% of the assets, mid cap companies take the rest of the position in the basket. The product is cheap, charging 59 bps in fees per year and it is highly liquid with average volumes of more than 7 million per day.

The product has rebounded nicely from the last year’s low and has delivered impressive returns of 3.59% year-to-date. The fund also yields an annual dividend of 3.78%, reflecting a strong commitment to enhancing investors’ returns.  

Taiwan AlphaDEX Fund (FTW)

This is a new fund issued by First Trust in February 2012. It uses a more active approach to replicate the price and yield of the Defined Taiwan Index, before fees and expenses. The index employs the AlphaDEX stock selection methodology, which uses fundamental growth and value factors to select stocks from the S&P Taiwan BMI universe. First Trust hopes that this technique will generate positive alpha relative to traditional passive indices.

The product holds 40 stocks in its basket having total assets of about $2.8 million. It allocates nearly 43% of its assets in top 10 holdings. Far EasTone Telecommunications and Hotai Motor Company take the top two spots, trailed by Advanced Semiconductor Engineering in third.

Coming to sector distribution, the product is heavy on information technology and consumer discretionary while light on industrials and energy. (Read: First Trust Planning More AlphaDEX ETFs)

This product is quite expensive relative to EWT, as it charges an annual fee of 80 bps. Further, trading volume is quite low, so total costs will be higher in this product as well.

However, given the merits of the AlphaDEX methodology, which seeks to give higher weights to the more promising firms and exclude some of the worst ranked stocks, it could still be an interesting choice for many investors. Additionally, it looks to offer a far less concentrated asset profile, possibly making it a better choice for those seeking a more spread out ETF, assuming they are willing to pay the higher costs of FTW.

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