A Cheap Way Into China?

In reopening its doors to China, Taiwan's newly elected government is also reopening a gateway to opportunity for foreign investors.

As a pure play on Taiwan, the iShares MSCI Taiwan Index Fund (NYSE: EWT  ) is poised to profit from the potential rejuvenation of Taiwan's domestic economy. As a bonus, it may also benefit if Taiwan succeeds in getting more latitude to invest directly in China's future.

Taiwan has performed quite well in recent years, with the iShares fund up 17.5% annually over the past five years. But that's well below the almost-26% annual return of the broader iShares MSCI Pacific ex-Japan Index Fund (NYSE: EPP  ) . In addition, ETF investors using the other gateway to China -- the iShares MSCI Hong Kong Index Fund (NYSE: EWH  ) -- earned almost 22% annual returns over the same period.

Ambitious rejuvenation plan
Due to its eight years of open defiance of China, Taiwan was marginalized both politically and economically. From 2002 to 2006, real GDP growth was 4.7% -- torrid by developed country standards, somewhat torpid by Asian ones. According to The Wall Street Journal, household income has risen a mere 3.5% cumulatively since 2000, and property prices have remained stagnant. In addition, Taiwan's tourism industry has suffered from low turnout.

Newly elected President Ma Ying-jeou has an ambitious "633" plan to change all that. He intends to raise growth to 6%, cut the jobless rate from 3.95% to 3%, and nearly double per capita GDP to $30,000. Direct flights will be allowed between Taiwan and China to attract mainland tourism, and the 40% limit will be lifted on Taiwanese companies' consolidated net asset value in China. Its banks may also be allowed to take a 20% stake in Chinese lenders through overseas units.

Among the Taiwan ETF's holdings that are poised to benefit from increased tourism are the country's two airlines, China Airlines and EVA Airways. In banking, Fubon Financial Holdings, with its Hong Kong subsidiary, is ready to service China's burgeoning wealth management needs

Enter the dragon
Yet Ma's ambitious plans could come to naught if China doesn't respond favorably. At a press conference, a Foreign Ministry spokesman said: "We will take various measures to aid Taiwan compatriots' external activities in areas of trade, health, and culture, and protect their lawful rights and interests overseas." In February, China also announced loan packages for some Taiwan companies and relaxed visa requirements for Taiwanese doctors.

Among the Taiwan ETF's top holdings, both Taiwan Semiconductor (NYSE: TSM  ) and AU Optronics (NYSE: AUO  ) already have invested in China. Once the new government takes office in May, these and other Taiwan companies should have a good shot at rebuilding their investments in China.

Check the risks
While any single-country ETF is risky, this Taiwan ETF arguably has much less political risk today than it did just a week ago -- at least judging from the positive rhetoric between the two countries. In addition to country risk, the ETF also has a high concentration in technology.

Nevertheless, for those looking for a way to profit from the growing Chinese market, the Taiwan ETF may represent a less expensive way to get exposure to China's economy. If things go well with Taiwan's attempts at reconciliation, moreover, investors could see more good days ahead.

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