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Mounting Pressure on TSMC ADR Arbitrage Strategy
The longstanding arbitrage tactic involving Taiwan Semiconductor Manufacturing Co. (TSMC), where investors buy shares in Taipei and short its US listing, is facing increasing challenges. Recent data indicates that excitement over artificial intelligence (AI) in the US has driven TSMC's American depositary receipts (ADRs) to their highest premium against the Taiwan stock since 2009. As of the most recent Friday, ADRs traded at a premium of around 21%, significantly above the five-year average of less than 8%. The premium even peaked at 30% during the Lunar New Year when the Taiwanese market was closed.
AI Frenzy Fueling Premium
The uptick in AI-related enthusiasm is a key driver behind this trend, making TSMC’s ADRs an attractive asset. This year until now, ADRs have surged 66%, outperforming Taipei shares' 55% increase, though both figures remain below their 2021 valuation highs. The accessibility of ADRs to foreign investors, combined with their inclusion in prominent indices such as the Philadelphia Stock Exchange Semiconductor Index, and various exchange-traded products, has heightened demand for these US-listed securities.
This disparity is fundamentally a consequence of supply and demand dynamics. Brian Freitas, founder of research firm Periscope Analytics, explains that not all foreign investors are eligible to hold Taiwanese stocks, prompting a preference for ADRs. Additionally, certain indices solely reference TSMC’s ADR, compelling ETFs to purchase US shares.
Regulatory and Ownership Constraints
Other factors contribute to the premium, such as the fungibility of ADRs. Unlike Taiwan shares, ADRs do not require special regulatory approval for conversion into US equivalents. Furthermore, fund managers already hold significant positions in the Asian security, limiting their ability to further increase holdings.
Potential Risks Ahead
Despite these dynamics, the AI sector remains buoyant. With industry giants like Nvidia Corp. surpassing $3 trillion in market value and semiconductor share indices reaching record highs, the ADRs' premium has averaged nearly 17% this quarter. Jon Withaar of Pictet Asset Management suggests the premium could still rise, posing potential risks for investors reliant on an eventual convergence to long-term fair value.
Broader Tech Impact
The AI boom’s influence extends beyond TSMC. Japan’s swift adoption of new AI tools positions it to significantly boost its economy and tech sector, according to Microsoft Corp. Japan President Miki Tsusaka. Additionally, TDK Corp.’s CEO noted that investors have not yet fully appreciated the current AI boom’s potential.
Looking ahead, market participants are advised to monitor the evolving dynamics carefully. While the premium on TSMC ADRs may continue to rise amidst the fervor around AI, it introduces complexities for those engaged in the arbitrage strategy, underscoring the delicacy required in navigating such investments.
