Recent news of rising chip prices has propelled Taiwan Semiconductor Manufacturing Company (TSMC) stocks to new heights, creating challenges for a popular Wall Street arbitrage strategy.
For years, investors have favored an arbitrage strategy involving buying TSMC shares on the Taiwan Stock Exchange while shorting its American Depositary Receipts (ADRs). However, this approach is becoming increasingly problematic.
According to media reports on Monday, the premium between TSMC ADRs and its Taiwan shares has surged to the highest level since 2009, reaching about 22% as of last Friday, significantly above the five-year average of around 8%. During the Lunar New Year holiday in February, when the Taiwan market was closed, the premium on TSMC ADRs peaked at 30%.
Jon Withaar, head of Asia at Pictet Asset Management, warned that many investors have been betting on this premium returning to a more reasonable long-term average. However, he cautioned that the premium could expand further, potentially leading to significant market disruptions.
TSMC's cutting-edge technology and reasonable valuations have made it a favored target for global investors focusing on AI investments. As of Friday, TSMC's ADRs had surged 66% year-to-date, while its Taiwan shares had climbed 55%. Despite these gains, both remain below their 2021 valuation peaks.
The outperformance of TSMC ADRs is partly due to the ease with which foreign investors can access ADRs. Additionally, TSMC ADRs are included in several key indices and ETFs, such as the Philadelphia Semiconductor Index, the VanEck Semiconductor ETF, and the iShares Semiconductor ETF, necessitating purchases by index-tracking investors.
Brian Freitas, founder of research firm Periscope Analytics, explained that supply and demand dynamics are at play. He noted that not all foreign investors can hold Taiwan-listed shares, so they prefer ADRs. Additionally, some indices only reference ADRs, forcing ETF funds to buy the U.S. stocks.
Freitas added that TSMC ADRs have consistently traded at a premium because they can be more easily exchanged, unlike Taiwan shares, which require special regulatory approval for conversion to U.S. stocks. Furthermore, fund managers in Asian markets already hold substantial amounts of TSMC stock, making it difficult to increase their positions further.
