Meet the Indices – Taiwan Equity Indices

In this installment of our “Meet the Indices” article series, we profile a number of benchmarks for the Taiwan equity market

Jackie Choy, CFA 28.03.2013
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There are a number of indices that offer pure and broad Taiwan equity exposure that are tracked by ETFs. These include the FTSE TWSE Taiwan 50 Index, MSCI Taiwan Index and TAIEX Index. These indices differ on a number of dimensions. Some are fairly concentrated, with just 50 constituents. Others are quite broad, covering the entire Taiwan stock market, with over 700 constituents.

There are also key similarities amongst these indices. In general, they have concentrated exposure to the technology sector (ranging from a 30-60% weighting). Taiwanese technology firms are key suppliers to the global hardware supply chain. This character makes an investment in Taiwan equities in many ways analogous to an early cycle technology play. Despite the broad range of the number of underlying constituents in the various Taiwanese equity indices and the corresponding differences in the relative weights of the key stocks, the indices have actually had very similar risk/return profiles over the trailing 1- and 3-year periods. In addition, the correlation between these indices has historically been very close to 1.

Here is a summary of the key indices tracking Taiwan equities:


Taiwan is classified as an emerging market by MSCI and FTSE. This classification may prompt investors to consider the potential diversification benefits of owning Taiwan equities in combination with developed market stocks, stocks from other emerging markets, and/or Chinese shares. Looking at historical correlations between the key Taiwan equity indices and other key equity benchmarks, the Taiwanese benchmarks showed a moderate degree of correlation (0.5-0.8) with other stock markets around the world during the trailing 1- and 3-year periods. These figures suggest that ETFs tracking these Taiwan equity indices could provide some diversification benefits when added to a global equity portfolio.

Interestingly, despite the increasing liberalization of trade and investment between Taiwan and China, Taiwan equity indices have a very low degree of correlation (<0.1 in the past 1 year, around 0.3 over the past 3 years) with the domestic Chinese equity indices (i.e. the A-Share market). Considering these figures, ETFs tracking these Taiwan equity indices are likely to offer a good degree of diversification for investors with a portfolio concentrated in domestic Chinese equities and vice versa. This finding is particularly important as there has been increasing demand from investors in Taiwan requesting that the RQFII scheme be expanded to allow Taiwanese funds/ETFs to invest directly into the domestic A-Share market in China.

ETFs Tracking Taiwan Equity Indices
There are a number of ETFs tracking Taiwanese stocks listed on various exchanges around the world. Investors should note that the Taiwan Stock Exchange (TWSE) has relatively short trading hours, with the market being open from 9am to 1:30pm local time. Investors trading ETFs tracking Taiwanese stocks trading on a different market and/or in a different time zone should exercise caution when an analyse the “premium” or “discount” between these ETFs’ market price and their ETFs’ NAV as well as their bid-offer spreads.


Index Construction

FTSE TWSE Taiwan 50 Index: The index is a free float-adjusted market capitalisation weighted, liquidity screened index consisting of the 50 largest stocks trading on the Taiwan Stock Exchange. The index is reviewed quarterly and changes are made as needed. The index represents over 70% of the Taiwanese market.

MSCI Taiwan Index: The Index is a free float-adjusted market capitalisation weighted index. The index targets all companies in the Taiwanese market with a market capitalisation within the top 85% of the Taiwan investable equity universe subject to a global minimum size requirement. The universe is initially screened for liquidity, as measured by the value and frequency of trading. The index is reviewed quarterly, with size cut-offs recalculated semi-annually.

TAIEX Index: The index is market capitalization-weighted and comprises all common stocks listed on the TWSE excluding preferred stocks, full-delivery stocks and newly listed stocks, which are listed for less than one calendar month.

Fundamental Performance Drivers of Taiwan Equity Indices
Taiwan is an export-driven economy (exports account for 70% of GDP), with China, the US, Japan, and ASEAN countries chief amongst the country’s key export partners. In February 2013, Taiwan’s real GDP for 2012 was provisionally estimated to have grown by 1.26% and projected to grow 3.59% in 2013 by the Directorate-General of Budget, Accounting and Statistics (DGBAS) in Taiwan. DGBAS projected that goods and services exports will grow by 6.35% in 2013, driven by the improving economic outlook for Taiwan’s main trading partners. As a result, the Taiwanese economy is expected to be sensitive to the global economy.

Trade and investment activities with Mainland China have been strengthening and liberalising in the past few years, thanks to the Economic Cooperation Framework Agreement (ECFA) signed in mid-2010. Since the signing of the ECFA, tariffs on a large list of products were reduced and the services and financial sectors on both sides of the Taiwan Straits were opened up for companies on either side, subject to certain rules and regulations. Further liberalising is expected to result from ongoing discussions between the two sides of the Straits and many Taiwanese companies are expected to benefit from the opportunities arising from the ECFA.

The technology sector is the largest sector component of the various broad Taiwan equity indices at 30-60%, with Taiwan Semiconductor Manufacturing (TSMC) (2230) and Hon Hai Precision Industry (2317) being the largest holdings within the sector and also the indices.

TSMC (which makes up 10% - 20% of these indices) is the world’s largest contract semiconductor chip manufacturer. Being an “upstream” company in the technology sector, TSMC will likely benefit from strong demand for smartphones given its economies of scale and leading technology. While it has a fairly diversified customer base, the competition between Samsung and Apple could bring in more business for TSMC and the potential for Samsung increasing the chip foundry prices it charges Apple could result in TSMC winning more business from Apple. That said, when analyzing TSMC and the technology industry, investors should note that the industry is steeply cyclical and highly competitive.

Hon Hai (5% - 8% within the indices), also known as Foxconn, is the world’s largest electronics contract manufacturer. With Apple as its largest customer, the sales growth momentum of the iPhone and iPad together with the strong competition from Samsung are the key swing factors affecting Hon Hai’s revenue. Given increasing component and labour costs (especially for factories in China), margins is a key area that the investors should focus on when analysing Hon Hai. 

Following the technology sector, the industrials/basic materials/chemicals (note that different index providers have different terminologies and classifications around these sectors) and financial sectors are fairly large, representing around 10%-20% of the makeup of each of these indices. For the industrials/basic materials/chemicals sectors, global economic growth will likely have an impact given the export-driven nature of these sectors. For the financial sectors, further liberalisation in the finance sector with Mainland China will likely benefit the sector as a whole but timing and regulation details could be hard to predict.

Foreign investors should also note that they are subject to withholding tax at 20% on dividends paid by companies in Taiwan. Total return indices will deduct this tax and hence it is reflected in the performance of these indices. ETFs domiciled outside Taiwan tracking these indices which utilise physical replication will also be subject to the withholding tax at the fund level.


Jackie Choy, CFA, is an ETF Strategist with Morningstar.

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Jackie Choy, CFA  is the Director of Passive Investment Ratings, Global Manager Research.

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