China tensions fail to dim outlook for Taiwan funds

The recent heightening of tensions between China and Taiwan are not currently a hindrance to the growth of Taiwan’s mutual funds market, according to a report on the country issued on Monday.

The Taiwanese market is identified as one of the most potentially fertile in the whole of Asia, given its size and “an openness that did not previously exist,” the report by Citi Prime, Futures and Securities Services said, despite a recent raising of tensions.

In an interview with international TV network CNN last week, Taiwan's President Tsai Ing-wen spoke about how Taiwan was prepared to withstand intimidation from mainland China. She added that Taiwan expects the international community to step in and defend it if ever Beijing used force in pursuit of its long-standing sovereign claims over the island.

For its part, China is taking an increasingly hard line. Last week, an Air New Zealand flight bound for Shanghai was forced to turn back because its paperwork referred to Taiwan, implying it is independent. The People's Republic of China refuses to have diplomatic relations with any country that recognises Taiwan (which calls itself the Republic of China) as an independent state. 

And yet when it comes to doing business there is a more collaborative atmosphere between the two, Citi reports.

Helping in that respect are the many Taiwanese-owned businesses in China. “It’s said that up to two million Taiwanese (out of a total population of 23 million) now live and work in mainland China,” Hong Kong-based Stewart Aldcroft, author of the report, said. “The frequency of daily flights across the 160 kilometre-wide Taiwan Straits has risen from zero 10 years ago to over 20 a day now, and it’s growing every year.”

“There are currently few restrictions on business,” he added, highlighting the growing potential opportunities on the island.

“Taiwan has in the past adopted a cloak of mystery about its mutual funds business, and getting to talk with the regulators was nearly impossible. But today, Taiwan’s a very different location for global fund houses.”

The aggregate size of the Taiwan mutual funds market exceeded $250 billion at the end of December 2018, according to data from local funds association SITCA, making it significantly larger than Singapore and on a par with South Korea. The total was made up of $104 billion in offshore funds, $84 billion in onshore local funds and $62 billion in investment mandates from pension funds and other institutional investors. There was a further $23 billion in exchange-traded funds (ETF).

Chart: Top 20 Foreign Managers in Taiwan ($ million)

Taiwan’s institutional market has grown substantially over the last 10 years. This is split between national pension funds, insurance companies and others. It’s estimated that the current size exceeds $300 billion, of which the five national pension funds exceed $150 billion.

Pension reform is seen as a key driver of growth in the retail funds space. Citi notes that the retirement system in Taiwan is still developing. “Despite it being one of the first in Asia to achieve nearly 100% coverage for all [its] citizens, the terms were relatively modest [and] many pension plans remain underfunded,” it said. “Due to widespread concerns about inadequate retirement savings, many Taiwanese are active in creating their own pool of accumulated savings, usually via mutual funds.”

Household savings regularly make up nearly 66% of gross national savings. While savings have increased, the rate of domestic capital investment hasn’t kept pace, with the savings rate in excess over investments reaching 12% in June 2018, resulting in a growing pool of idle funds, the report added.

The institutional market is also expected to expand strongly, as pension funds and insurers look to follow the lead of the Bureau of Labor Funds (BLF) into alternative assets, private equity and specialist mandates.

Earlier this year, Cathay Life, the biggest life insurer in Taiwan, began ramping up its allocations to fixed income ETFs to capture potential gains in a changing credit environment. The move was expected to be copied by other insurers after new rules were introduced to limit investments into Formosa bonds – foreign-currency issues by non-domestic companies in Taiwan.

Chart: Taiwan's insurance company allocations into foreign funds

Bond ETFs that track foreign indices and are denominated in local currency can enable insurers to gain indirect overseas exposure without reporting them as foreign assets, which are capped at 65% of total investable assets. Taiwanese insurers are thought to account for about 70% of the investment into bond ETFs issued by local fund houses.

Citi estimated that up to 50% of the assets under management of the five underlying BLF pension funds has been allocated to global or overseas securities, with a high proportion as third-party mandates with foreign fund managers.

There have been moves in other directions too.  As reported, the NT$3.93 trillion ($127 billion) state pension fund offered its first domestic environmental, social, and governance (ESG) mandate totalling NT$42 billion in May last year.

Yuanta Securities Investment Trust Enterprises (Site) also won a mandate last month from Taiwan Index Plus and FTSE Russell to issue an ETF that tracks their FTSE4Good TIP Taiwan ESG Index – the first ESG index in Taiwan that measures the performance of companies meeting globally recognised ESG standards. It is set to roll out the first-ever ESG ETF in Taiwan in the first half of 2019.