The long-favoured arbitrage strategy of buying Taiwan Semiconductor Manufacturing Co’s (TSMC) Taipei shares while shorting its US listing is starting to become painful.

The enthusiasm over artificial intelligence (AI) in the US has pushed TSMC’s American depositary receipts (ADRs) to their most expensive price versus the Taiwan stock since 2009 this quarter, data compiled by Bloomberg showed. As of last Friday, they traded at a premium of around 21%, compared with less than 8% for the five-year average. It reached a high of 30% during the Lunar New Year in February, when the Taiwanese stock market was closed. 

“A lot of people have set it up, and are hoping that it collapses back to its longer-term, fair value level,” said Jon Withaar, the head of Asia special situations at Pictet Asset Management. But the premium could still go higher, “and then there’ll be a lot of pain”, he added.

TSMC’s cutting-edge technology and reasonable valuation have made it a favourite play among global investors in AI. The ADRs have surged 66% this year through last Friday, compared with a 55% advance in Taipei shares. Yet both are trading much lower than their valuation highs of 2021.

The ADRs have outperformed because they are more easily accessible to foreign investors. They are also included in gauges like the Philadelphia Stock Exchange Semiconductor Index and in exchange-traded funds (ETFs), such as the VanEck Semiconductor ETF and iShares Semiconductor ETF, meaning that funds tracking them must buy the US-listed securities. 

“It’s supply/demand dynamics,” said Brian Freitas, the founder of research firm Periscope Analytics. “Not all foreign investors can hold the Taiwan stock, so they just prefer owning the ADRs. Plus, there are some indices which only reference the ADR, so ETFs then basically buy up the US shares.”

Beyond that, TSMC’s ADRs have typically traded at a premium because they are fungible, unlike the Taiwan shares, which need special regulatory approval to be converted into the US equivalent. The Asian security is also already heavily owned by fund managers, making it difficult for them to increase their position further. 

For now though, the AI sector remains hot, with Nvidia Corp worth more than US$3 trillion in market value and a gauge tracking semiconductor shares at a record high. TSMC’s ADR premium over the local stock has climbed to an average of almost 17% this quarter after reaching 30% in February. 

“The AI boom is not over,” Withaar said. “I am happy to wait for a crescendo widening and perhaps even panic unwinding.”

  - Bloomberg