TWN CEF: No FOMO, Ride The ‘AI 5’ Tailwind With This Hated Fund (NYSE:TWN)

Taiwan fund overview

Taiwan Fund Inc (NYSE:TWN) is a closed-end fund that focuses on actively managing a portfolio of stocks listed on the Taiwan Stock Exchange, to achieve long term capital growth. According to the fund’s website, it will “invest more than 25% of its total assets in the semi-conductor industry.”

The investment advisor is Nomura, and Nomura Taiwan specifically has a dedicated team specializing in managing this fund. The investment team has experience continuously managing equity mandates in Taiwan dating back to 1998. Its investment philosophy is centered on bottom-up stock picking with a growth orientated bias.

Portfolio managers Sky Chen and George Hsieh have 17 and 21 years respectively of investment experience in the Taiwan investment industry.

Taiwan fund facts

The Taiwan Fund has reasonable enough scale with around $330 million of assets under management.

A distribution is usually paid annually, but investors should bear in mind that the objective here is for long term capital growth.

The expense ratio is listed as marginally below 1.5%. Such a fee is not so unusual for actively managed emerging market equity funds. Importantly in this case, and unlike many other funds, the Taiwan Fund appears to be justifying the fees they charge with adequate performance.

Below are the key facts of the Taiwan Fund at a glance.

Taiwan fund past performance

Investors in the Taiwan Fund are likely to be happy given the historical performance as illustrated below.

Taiwan fund or an ETF instead?

Whilst there are no guarantees it will continue in the future; the historical performance of the Taiwan Fund would have seen their investors do better than an ETF.

Over the last decade at least, active management has worked out ok in this case. One could make a case here that the prospects are favorable for this added alpha to continue.

Many would argue that active management is more likely to stack up in emerging markets such as Taiwan compared with developed equity markets. We can also get some comfort from the very experienced portfolio management team they have based in Taiwan.

Taiwan fund distribution history

The Taiwan fund’s goal is not to deliver steady distribution income, but rather achieve long term capital growth.

Below are the fund’s historical distributions over the last decade, that are usually paid on an annual basis.

Is TSMC to make it the magnificent 8?

A huge boost to the performance of the Taiwan Fund recently has been from Taiwan Semiconductor Manufacturing Company Inc (TSM), which represents about 20% of the portfolio.

From the Taiwan Fund’s recently reported December monthly insights, it was noted, “With the end of CSP’s inventory adjustments, new demand is anticipated to drive the recovery of the server market, with significant growth in total AI server shipments for 2024. Beyond AI servers, additional applications such as AI personal computers and AI smartphones have been introduced to the market. We anticipate a continued increase in market penetration for AI-enabled devices, providing sustained benefits to Taiwan’s supply chains.”

This view has led the Taiwan Fund to still remain bullish on TSMC in 2024, despite being of the opinion that US interest rates are likely to remain at an elevated level for some time.

The Taiwan fund gives you an interesting way to get some exposure to TSMC, with its recent performance prompting the question whether this will soon make TMSC a top ten world stock? To quote from this linked article, “The surge in TSMC’s stock price mirrors investor optimism about the future growth prospects of AI technology,” said Bloomberg Intelligence analyst Charles Shum. “The company is the most critical supplier of Nvidia’s AI chips,” he added.

TSMC could get more publicity globally amongst investors if they gravitate to a new phrase such as the “magnificent 8” or “elite 8”. Some believe if we were to add a an eighth company to the bundle, the easy choice would be for the “magnificent 8” to include TSMC.

How to invest in part of the “AI 5”?

Speaking of new phrases in the stock market, some are pushing to group together five certain stocks to make up the “AI 5”. Were this to gain further traction in 2024, one can make a case that TSMC is the most undervalued AI5 stock right now. This article just mentioned from a few days ago, notes some recent valuation metrics of the AI5.

Please note that it is hard to keep pace with Nvidia’s earnings forecasts rising and valuation multiples falling, so above is already out of date in that respect.

My point stands however that it is not difficult to foresee a scenario that fund managers getting a bit of FOMO, could turn to Taiwan’s TSMC in some hope to play catch up.

Of course, TSMC is circa 20% of the Taiwan Fund, so you are not only investing in this theme with the Taiwan Fund here.

It is worth mentioning the high weighting the fund has to TSMC though, because interestingly, sentiment of the Taiwan Fund is terrible.

Sentiment on the other hand towards the magnificent 7 and AI5 is going gangbusters.

Why is there terrible sentiment towards the Taiwan Fund?

I have explicitly mentioned many key facts about the Taiwan Fund, but have yet directly discussed the discount to NAV.

I thought that might lead to readers themselves pondering what the discount was. The fund seems to be delivering on its long-term objectives. Unlike many other CEFs, it has done a solid job when compared with similar ETFs. The investment team is experienced, investing plenty in a sector that is popular right now.

The fund also has a policy of a potential tender offer of 25% of the shares at near NTA. This can come into play if the fund underperforms its benchmark. It is very unlikely this will come into play late next year though for a good reason, that is the fund is outperforming by so much in recent years.

I mention it simply as it shows the fund is willing to take steps to address the discount issue. It could also be a sign that activists have been looking at the fund in the past and may continue to do so in the future.

Given all the above, I would not necessarily expect the discount to NAV to be extremely wide.

Contrary to such expectations, at year end the discount was a large 21% to NAV as we can observe from the very long-term chart below.

Such a large discount to NAV is sometimes a symptom of a CEF that has seriously underperformed and therefore hated by investors.

In this case however, the large discount may well come down to the fund being shunned by US investors due to geopolitical risks. I shall cover that a bit further down in this article.

For the time being, the point I would like to make is that the discount nonetheless seems very wide. After all, investors happily have billions of dollars invested in US listed Taiwan ETFs despite the same geopolitical risks being relevant.

Taiwan economic outlook in 2024

Consensus for Taiwan is centering around a year where GDP remains fairly stable at circa 3%. It could provide a good backdrop for the whole Taiwan stock market given it reads of a pickup in most sectors of the economy. The improvement looks gradual enough so that inflation remains at a tame sub 2% level.

The Taiwan government is bullish that although TSMC has got plenty of attention about its plans offshore, its domestic expansion plans are a positive sign for the wider economy.

The significance of this is not to be underestimated, to quote from the linked article above, “TSMC, whose chips are used in everything from iPhones and cars to AI and quantum computing applications, is such an important company for Taiwan’s trade-dependent economy it is widely referred to as “the sacred mountain protecting the country.“

Are Taiwan shares still cheap?

Although the market has already performed strongly in recent times there can be an argument made that there is still room for further upside. With NVIDIA Corporation (NVDA) beating earnings estimates this week, analysts are recognizing the correlation to the trends in markets such as Japan and Taiwan hitting fresh highs .

The chart below suggests Taiwan’s market may have some room for catch up to do compared with the Nikkei and Nasdaq.

If one is to examine longer term price to book ratios of Taiwan shares, although they have risen in the last year, it does not seem too alarming.

I was looking at the above chart recently as I do believe South Korean stocks are cheap, which I discussed here last week.

Having said that, the other markets above despite performing much better in the last year, do not look too extended to me. In the context of some of the favorable sector tailwinds for Taiwan, the above positive re-rate in price to book ratios are warranted.

Taiwan fund sector allocations

Taiwan fund top holdings

Geopolitical risks, the Taiwan fund discount, and discounts on Taiwan shares

Some readers will not doubt say such a discount above on the Taiwan Fund and holdings within it, are perfectly rational because of geopolitical risks.

The risk of China invading Taiwan will lead to some investors declaring the Taiwan market as “uninvestable”.

Firstly, such a scenario is catastrophic for the Chinese economy. This fact alone means most observers rationally view it as a tail risk of which not to base one’s portfolio strategies around. Such an invasion would see TSMC factories under threat, and in turn the entire world’s crucial global supply chains disrupted. From that perspective, how China stands to win from such a move is hard to fathom.

More background of my last paragraph above can be explained here. This article explains how if China invaded Taiwan, the implosion of the microchip industry would negatively affect everyone. To quote directly, “Taiwan alone manufactures more than 60% of the world’s semiconductors -— and crucially, 90% of the most advanced ones.”

If one is specifically avoiding the Taiwan Fund due to the possibility of China invading Taiwan, they may want to rush out and sell some US tech stocks. Big US tech firms are obviously so reliant on Taiwan’s manufacturing. Yet the way they have been rallying of late to now represent such a high proportion of the S&P500, shows investors are apparently not too concerned there.

Consider the Taiwan fund as a way to avoid FOMO on the AI theme

We rarely seem to hear about “China risks” when investors dive into the “magnificent 7” stocks with enthusiasm lately. At the same time, the large discount to NAV of the Taiwan Fund, and valuations within it, imply that investors are placing plenty of weight on such risks there.

This presents plenty of scope for the likes of TSMC and the broader Taiwan stock market to positively re-rate further on a relative basis, compared with many large US tech stocks.

I therefore regard the Taiwan Fund as an interesting idea to consider obtaining some partial exposure at least to the AI theme that is running hot right now.

The fact that I described it as “running hot”, precludes me for the time being labelling the Taiwan Fund as an outright buy right now.

It may however be a clever unusual way to ride more of the AI tailwinds for 2024, perhaps a good one for the watchlist. The Taiwan Fund may become a good buy on dips in the coming months, should some of the current enthusiasm in AI wane and we see a correction.