Taiwan Semiconductor ADR rose too sharply, Wall Street can't handle "arbitrage trading" anymore

Recent news of chip price hikes has driven Taiwan Semiconductor's stock price soaring, making Wall Street's "arbitrage trading" increasingly painful.

For a long time, the favored arbitrage strategy by investors has been to buy Taiwan Semiconductor's Taiwan-listed shares while shorting Taiwan Semiconductor's American Depositary Receipts (ADRs). However, this strategy is starting to become outdated.

According to media reports on Monday, the premium between Taiwan Semiconductor's ADR and Taiwan-listed shares has climbed to the highest level since 2009, with the premium reaching about 22% as of last Friday, far exceeding the 5-year average of around 8%. During the Lunar New Year period in February, when the Taiwan stock market was closed, the premium for Taiwan Semiconductor's ADR reached as high as 30%.

Jon Withaar, head of Pictet Asset Management's Asia division, warned:

Many are betting on this, hoping that the premium will eventually fall back to a more reasonable long-term average level, but the premium may further expand, bringing significant impact when that happens.

Cutting-edge technology and reasonable valuation have made Taiwan Semiconductor a hot target for global investors to position themselves in AI. As of last Friday, Taiwan Semiconductor's ADR has surged by 66% year-to-date, while Taiwan-listed shares have risen by 55%. However, both stock prices are still well below their valuation peaks in 2021.

The outperformance of Taiwan Semiconductor's ADR is due to foreign investors finding it easier to invest in ADRs, which are included in multiple important indices and ETFs, such as the Philadelphia Semiconductor Index, VanEck Semiconductor ETF, and iShares Semiconductor ETF. This means that investors tracking these indices must buy Taiwan Semiconductor's American ADRs.

Brian Freitas, founder of research firm Periscope Analytics, explained:

This is driven by supply and demand dynamics, not all foreign investors can hold Taiwan-listed shares, so they prefer to hold ADRs. In addition, there are some indices that only reference ADRs, so ETFs also have to buy U.S. stocks.

Furthermore, Taiwan Semiconductor's ADRs have always had a trading premium because they are interchangeable, unlike Taiwan-listed shares that require special regulatory approval to convert to U.S. stocks. Additionally, Taiwan Semiconductor's shares in the Asian market are heavily held by fund managers, making it difficult to further increase holdings in the stock