Lazard’s Donald: I hold TSMC despite ‘gigantic’ China-Taiwan risk

Source: Trustnet

The threat of a China-Taiwan conflict poses a “gigantic” risk to investors, according to James Donald, co-manager of the Lazard Emerging Markets fund.

Investors are still underestimating the fallout of a potential major escalation in Asia, where repercussions would be ever greater than those following Russia’s invasion of Ukraine.

“Unless you run an ex-China strategy – which we don’t – you can’t really sidestep the risk, which is gigantic,” he said. “If China did invade Taiwan, the global economy would face serious dislocation.”

China and Taiwan together account for nearly half of the manager’s universe, making this a very front-and-centre risk for Donald. In the benchmark, China represents 10 times Russia’s weighting at the time of the Ukraine invasion.

He is perhaps even more attuned to this risk following the start of the Russia-Ukraine conflict, having previously been overweight the Russian market prior to the war.

“We had more than the index’s 4% invested in Russia. We found some very reasonably priced companies with very high profitability there,” he said. It was a decision that proved “painful, but not a body blow”, he said. China invading Taiwan, however, would be far more impactful.

Despite this, Donald Taiwan Semiconductors (TSMC) is his fund’s top position, due to what he sees as its unrivalled competitive advantages. “TSMC is a phenomenal company, with a very high and stable return on equity of around 30%.”

It represents 4.1% of his £981m Lazard Emerging Markets portfolio, which he argued was “a modest position compared to many other investors”.

That positioning has paid off recently: TSMC was the fund’s top contributor over the past 12 and 18 months, adding 1.76 and 2.16 percentage points respectively.

Still, the manager admitted the position comes with caveats. “Holding TSMC in that scenario [of a China-Taiwan escalation] would be a problem,” he said.

While the company is developing fabrication plants in the US and elsewhere, Taiwan remains central to its operations.

That said, he has trimmed the stake, citing valuation and concentration risk. On top of that, he also holds companies that work with TSMC, such as ASE Technology, which specialises in testing and packaging.

“These companies are less profitable but more attractively valued, so the upside is greater,” he said.

His base case remains that China does not invade, as president Xi Jinping is “probably understands that the Chinese economy isn’t positioned to handle severe sanctions or global instability,” he said. “He’s already grappling with existing sanctions. I also doubt the army is ready for a major conflict. But the risk is real.”

Beyond the Taiwan issue, Donald is wary of other structural risks building in global markets. “We’re in a high-return, high-risk world. Tariffs are a major concern. If they rise meaningfully, that could be a big problem,” he said.

“At this point, we think two things are very likely: higher tariffs and lower global growth. If both trends worsen – higher tariffs and zero or negative growth – that’s a bad scenario for equities and for emerging markets.”