Investors in the Taiwan stock market largely are ignoring what could be a serious threat to the country from mainland China as the inauguration of Taiwan's new pro-independence president is set to take place.
Nandu Narayanan, portfolio manager at Trident Investment Management LLC, New York, said the Chinese are more concerned with saving face than with the economic repercussions of attacking Taiwan, and investors should not ignore the possibility of violence.
"Too many people think it's not a big deal. The market is ignoring the risks of the situation," said Mr. Narayanan.
Trident has cut the weighting of Taiwan in its emerging markets portfolio by 75%. Taiwan now represents about 2% to 3% of the portfolio, less than one-quarter of the weight it should have according to the benchmark, the Morgan Stanley Capital International Emerging Markets Free index.
"The issue of Taiwan runs a lot deeper than economic ties (for China). If they let Taiwan have independence, why not some other provinces?
"There is a substantial risk here," Mr. Narayanan said.
Chen Shui-bian, the new president from Taiwan's pro-independence Democratic Progressive Party, is scheduled to be inaugurated May 20.
Taiwan's stock market has shown some volatility since Mr. Chen's election. It went down 4.3% on April 26 when China began military training exercises.
But more recently, it has been relatively calm, climbing 1% between April 26 and May 9.
Douglas Dooley, managing director and emerging markets portfolio manager at J.P. Morgan Investment Management Inc., New York, said his firm also has cut its Taiwan exposure.
"We're underweighting Taiwan exposure by 3% to 4%. We're at 8% now," Mr. Dooley said, which is three percentage points less than the benchmark exposure.
The election "has created tensions with China that are not likely to fade soon," he added. "The degree to which Taiwan is pushing the envelope with China, by using terms like `state to state' in discussions, could have ramifications."
Mr. Dooley also pointed out that with foreign investment restrictions, the largest holders of Taiwanese companies' stocks are the Taiwanese people, who might want to move money out of the stocks to diversify their holdings.
But he also said he doesn't think the Chinese would use force against Taiwan, at least for now. "We are braced for unpleasant speech, white papers and the Chinese demanding a one-China policy from the U.S., but aren't expecting something bigger than that now," he said.
Said Kenneth King, managing director at Rexiter Capital Management Ltd., London: "Every time you think the Taiwanese have factored in the issues (with mainland China) the mainland rattles its sabers and the market goes crazy."
Mr. King believes the stock market could come down as much as 20% if the new president says anything that upsets China.
"All he has to do is say `we're a separate country' or `we want to be separate' and it will cause problems," Mr. King said.
Rexiter, however, is not reducing its holdings of Taiwanese stocks. "The disturbance we're expecting will be transient. It's always possible there will be a scare and the market will come off a bit, but that will be a short-term thing," he said.
He, too, pointed out that with restrictions on what investments foreigners can make in the Taiwan stock market, a panic caused by foreigners isn't likely.
Any problems in the Taiwan stock market would come at a very bad time, just as Taiwan's weighting in the MSCI Emerging Markets Free index is being increased. It will be raised to 13.3% from slightly less than 12% of the index as of May 31. Its weighting is supposed to be raised again at the end of November and then next May, when it is set to make up about 20% of the index.
"If the Chinese start taking a much more aggressive posture it would not bode well for the market," said Steve Saeger, an emerging markets portfolio manager at Barclays Global Investors, San Francisco.
However, he thinks any action by the Chinese is unlikely.
"The new president has toned down his rhetoric dramatically and there will be work on both sides to reduce tensions," he said. "There might even be a stronger economic linkage between the two countries and that would reduce political tensions."
But he thinks China would postpone any drastic action until at least after the U.S. Congress votes this spring on giving China normal trade status and the country gains entry into the World Trade Organization.
He thinks the Chinese "will only up the ante in terms of rhetoric before the inauguration. If there were any military exercises that would make it worse. Hopefully, it won't reach that point."
Barclays doesn't expect it to and is holding Taiwan stocks at the full weighting of the benchmark.
As the inauguration draws near, "I think you will see more statements made by China to save face, but they will be more subdued," said James Seymour, managing director in charge of international private equity at The Commonfund Group, Wilton, Conn.
He thinks there could be some temporary dislocations in the Taiwanese stock market.
However, he believes China's concern about getting into the WTO will restrain it from taking any more serious action.
In its international private equities program, Commonfund has managers with investments in Taiwan
"I don't think the decision-making is driven by politics or rhetoric. I think it's driven by technology," Mr. Seymour said, noting Taiwan's economic base has been built on technology companies.