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In the News: 2003

Funds take a closer look at Taiwan — Deregulation draws foreign investors to smaller stocks

Taiwan's decision this month to remove all remaining restrictions on foreign investment in the island's stock market has given fund managers like Edmund Harriss an incentive to increase their holdings, not only of Taiwan's largest companies but of smaller ones as well.

Smaller companies whose shares do not trade outside Taiwan - including Fu Sheng Industrial, a manufacturer of compressors and golf club heads whose stock has risen 45 percent for the year - may soon be in greater demand.

This month's lifting of restrictions "will suck in an enormous amount of money," said Harriss, a London-based fund manager at Guinness Atkinson Asset Management who has 25 percent of his $125 million in Asian funds invested in Taiwan. "I'm in adding mode," he said.

The TWSE index has climbed 35 percent in dollar terms this year. Many investors are betting that the country will soon have more weight in indexes compiled by Morgan Stanley Capital International, which penalizes countries that restrict foreign investment.

On Oct. 1, Taipei scrapped a 12-year-old rule that capped investment in the island's stock market by foreign institutions to $3 billion. Because of the cap, Taiwanese companies have only about 55 percent of market value represented in MSCI's indexes, the benchmark for about $3 trillion in investments.

Last week, MSCI said it was to begin a three to six-month assessment of the government's action before announcing any changes to its indexes. Any changes would take effect four to six months later, the company said.

Foreign investors are anticipating that Taiwan's weighting in the MSCI benchmarks will eventually increase. They have bought a net 477 billion Taiwan dollars, or $34 billion, of Taiwanese stocks this year, according to stock exchange figures. That is more than their net investment in the previous three years combined.

MSCI's weighting for Taiwan in its Far East Free ex-Japan regional index could increase to 29 percent from the current 19 percent because of the deregulation, said Spencer White, a strategist at Merrill Lynch in Hong Kong.

As much as $35 billion more may flow into Taiwan's stock market in two years if MSCI adjusts its indexes, Peter Sutton, head of Taiwan research at the CLSA Asia-Pacific Markets brokerage, wrote in a research report last week. The estimate is based on the flow of money into South Korea's market between 1997 and 1999 as it was opened to overseas investors.

Before Oct. 1, investors that did not have qualified foreign institutional investor status, or QFII, in Taiwan were restricted to buying depositary receipts in Taiwanese companies, which are listed overseas.

But only a select number of Taiwan's biggest companies offer such securities. American depositary receipts, or ADRs of Taiwan Semiconductor Manufacturing and United Microelectronics traded for more than the value of their underlying shares as a result.

Taiwan Semiconductor's ADR premium has narrowed by two-thirds since the end of April, and stood at 11 percent as of Thursday's close. Since Sept. 5, the premium paid for United Microelectronics has shrunk by more than half, to 12 percent.

For many fund managers, the stock market liberalization in Taiwan means that they will now be able to invest directly in a wider range of stocks that do not have listings overseas.

Shares of Fu Sheng, for example, have risen 45 percent this year. They trade at 16 times forecast earnings, according to the average estimate from Thomson Financial. The comparable figure for the TWSE index is 22 times.

"We need to expand our coverage to look at more non-tech," said Winson Fong, a fund manager at SG Asset Management in Singapore. "A lot of companies which are non-tech stocks are exporting to the U.S., have customers in China, and are doing well."

Fong's example is one that more investors may choose to follow now that Taiwan's restrictions on their stock holdings have been lifted.

"People are putting money back," said James Squire, a fund manager at Baring Asset Management (Asia) in Hong Kong. "There's an earnings story, a technology story, and there's a very strong liquidity argument."