TSMC, US Stock Premium Hits 15-Year High, Arbitrage Trading Faces Risks

According to Zhitong Finance, the long-term arbitrage strategy of buying Taiwan Semiconductor (TSM.US) stocks in Taipei, China, while shorting its US-listed stocks, has begun to bring pain to investors. Data shows that the enthusiasm for artificial intelligence in the United States has pushed the price of Taiwan Semiconductor's American Depositary Receipts (ADR) to the highest level since 2009 relative to Taiwan Semiconductor. The current premium is about 22%, while the 5-year average premium is less than 8%.

Jon Withaar, Head of Special Situations in Asia at Pictet Asset Management, said: "Many people have built this fund hoping it will fall back to long-term fair value levels. Earlier this year, due to the artificial intelligence boom, this spread reached 30% at one point, and it could happen again - which will cause a lot of pain."

Taiwan Semiconductor's cutting-edge technology and reasonable valuation have made it a favorite among global artificial intelligence investors. As of last Friday, its ADRs have surged 66% this year, while the Taipei stock market has risen 53% over the same period. However, both stock prices are far below their valuation highs in 2021.

The outperformance of Taiwan Semiconductor's ADRs is due to the ease of foreign investors to invest. It is also included in indices such as the Philadelphia Semiconductor Index, as well as exchange-traded products like the VanEck Semiconductor ETF and iShares Semiconductor ETF, which means funds tracking them must buy securities listed in the US.

Brian Freitas, founder of research firm Periscope Analytics, said: "This is a supply and demand dynamic. Not all foreign investors can hold Taipei stocks, so they prefer to hold ADRs. In addition, some indices only reference ADRs, so ETFs basically buy all US stocks."

In addition, Taiwan Semiconductor ADRs usually trade at a premium because they are fungible, unlike Taipei stocks that require special approval from regulators to convert to ADRs. Furthermore, Taiwan Semiconductor's Taipei stocks are heavily held by fund management companies, making it difficult for them to increase their holdings further.

However, for now, the artificial intelligence sector remains hot, with NVIDIA (NVDA.US) surpassing a market value of over $3 trillion, and an index tracking semiconductor stocks hitting a historic high. After reaching a 30% premium relative to Taipei stocks in February, Taiwan Semiconductor's ADR premium has climbed to an average of nearly 17% this quarter. Freitas said: "The prosperity of artificial intelligence is not over yet. I am willing to wait for the market's climax to expand, even as panic subsides."