FLTW - EWT: Improved Taiwan Risk/Reward Heading Into Election Season

2023-12-17 09:58:31 ET

Summary

• Following a dismal 2022, Taiwanese equities are set to end the year higher.
• Looking ahead, the fundamental and technical setup is as compelling as ever ahead of election season.
• EWT isn't cheap, but its valuation is well-supported by an attractive growth/income combination.

It's been a topsy-turvy year for the iShares MSCI Taiwan ETF ( EWT ), and while the fund did dip meaningfully since I last covered it, EWT now looks poised to end the year on a high. One key reason for the Q4 rebound has been Taiwan's approaching election, a key theme heading into 2024. Polling has been tight , and while the incumbent Democratic Progressive Party (DPP) is in the lead, the opposition retains a strong chance of winning through a coalition comprising the center-right Kuomintang ((KMT)) and center-left Taiwan People's Party ((TPP)). Hence, recent news that KMT and TPP candidates had registered under separate tickets raises the likelihood of policy continuity - news that appears to be welcomed by the market. Easing US-China tensions in recent months has also helped, driving a lower geopolitical risk premium ahead of election season.

While I don't think the geopolitical risk has completely disappeared in the long term, easing tensions does pave the way for fundamentals to take precedence again. Here, Taiwan's leverage to tech hardware supply chains means the state of the global tech cycle is particularly crucial. Recent export data shows a clear divergence between more cyclical 'legacy' tech (currently in decline) and secular growth opportunities from artificial intelligence (growing strongly). Similarly, Taiwan has also been caught in an economic divergence between declining Chinese exports and record-high US-bound tech exports.

With an additional technical boost from the latest FOMC rate path reset , allowing foreign investors to reallocate back into Taiwan, stocks have rebounded on the optimism. As a result, Taiwanese stocks aren't cheap at ~15x forward earnings (~13x trailing), though a consensus high-teens % growth pace next year helps (albeit off a lower base due to the high-teens % decline this year). Plus, the iShares MSCI Taiwan ETF ( EWT ) is still a long way off its prior cycle highs, so the fund is still worth a look for those looking to ride a cyclical and secular chip rebound. In the meantime, investors get paid an attractive ~4% yield to wait.

iShares MSCI Taiwan ETF Overview – A Taiwanese Portfolio Highly Levered to Tech

The US-listed iShares MSCI Taiwan ETF tracks, before fees and expenses, the total return performance of the MSCI Taiwan 25/50 Index, a basket of large-cap Taiwanese equities subject to the following constraints – 1) <25% of assets invested in a single issuer and 2) cumulative weights of all >5% fund holdings should not be over 50% of total assets. The ETF held ~$3.7bn of assets at the time of writing, down from prior quarters, though it maintains a ~0.6% expense ratio. By comparison, smaller US-listed comparable, the Franklin FTSE Taiwan ETF (FLTW), charges a much lower 0.2%.

The EWT portfolio is spread across an expanded 93 holdings, with the Information Technology sector allocation further increasing to 62.3% through Q4. Financials remains the second-largest allocation at 18.2% (broadly unchanged), followed by Materials at a slightly lower 5.6%. The rest of EWT's sector exposures remain well below the 5% threshold, most of which have ceded portfolio share to tech. At ~94%, the ETF is even more heavily tied to its largest sectors than before and remains one of the most concentrated Asian ETFs by sector exposure. As the tech-heavy portfolio composition is also echoed in key comparable FLTW, however, investors don't have too many choices in this regard.

EWT's single-stock allocation also skews heavily toward semiconductor foundry Taiwan Semiconductor Manufacturing (TSM), albeit at a slightly lower 22.1%. Fabless chip company MediaTek ( MDTKF ) is now the second largest holding at 4.7%, while the third-largest allocation, electronics manufacturer Hon Hai Precision (HNHPF), has seen its allocation cut slightly to 4.1%. The rest of the top five is filled with familiar tech names like electronics player Delta Electronics ( DLELY ) and foundry United Microelectronics Corporation (UMC). Like FLWT, no non-tech exposure crosses the >2% threshold, reinforcing the notion that Taiwanese large-caps funds are highly levered to the broader tech cycle. With the top five holdings contributing ~35% of the overall portfolio, EWT also remains as concentrated as ever from a single-stock perspective.

iShares MSCI Taiwan ETF Performance – Tech-Driven Capital Growth with an Attractive Income Supplement

On a YTD basis, the ETF has been the pick of Asia, returning +24.4% on the back of a steep Q4 rally. Zooming out, this year's rebound (recall EWT declined -28.8% last year) has also brought the five and ten-year NAV return up to an impressive +14.0% and +9.7%, respectively. EWT's outperformance over the last decade makes up for its underwhelming early years, keeping the overall rate of compounding at a +4.0% pace (market price and NAV terms) since its inception in 2000. The catch here is that the fund's returns come with a lot of volatility - in line with its concentration in 'picks and shovels' tech supply chain stocks, which generally track the global tech cycles. Given their similar portfolio holdings, performance numbers are in line with lower-priced comparable FLTW as well.

Another major plus for EWT investors is its income - distribution currently runs at a very attractive ~4% on a trailing twelve-month basis, though this can move even higher depending on capital gains. Cash-generative holdings also sustain the fund's strong yield, so EWT should remain among the highest-yielding Asian ETFs for many years to come. The catch is that EWT's combination of income and capital growth appeals to a broader investor base, so the fund tends to trade at higher multiples by Asian standards. No surprise then that EWT's portfolio is pricey at ~13.5x P/E (~15x fwd) and ~2x P/B, though a high teens % earnings growth rate next year and a steeper rate cut cycle mean the valuation isn't unreasonable.

Better Risk/Reward on Taiwan Heading into Election Season

Having been punished for China-related geopolitical concerns earlier this year, easing US-China tensions has allowed the market to refocus on the underlying fundamentals of Taiwanese stocks. On the one hand, the tech-heavy Taiwan index is levered to a cyclical downturn in the broader semiconductor cycle. Yet, the leading edge, spearheaded by the rise of compute-intensive large language models, is keeping earnings strong. Given the growing AI ambitions across the globe, Taiwan's supply chain may well benefit via second and third-order long-run benefits as well. So even with many Taiwan companies levered to a slowing China, earnings growth could still re-accelerate from here.

Plus, tech valuations have historically been a prime beneficiary of rate cuts, and if the latest FOMC was anything to go by, US-led monetary easing will be on the menu next year. To be fair, some of the positives are likely priced into EWT at the current high teens forward earnings multiple. Relative to the combination of a high teens % growth next year and a ~4% yield, though, investors could still come out ahead.

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