During the second quarter of 2025 the strategy underperformed the MSCI Emerging Markets index by 2.7%, broadly reversing the outperformance from Q1. Punctuated by significant volatility following “Liberation Day” tariff announcements, our markets initially sold off but ultimately delivered solid gains in USD terms.
The largest drag this quarter came from TWD hedges as a significant portion of Taiwanese returns came via sudden currency appreciation. While this was offset in absolute terms by the equity portfolio, relative to the unhedged index this generated underperformance. Stock positions in China also underperformed as some of the internet giants we hold have engaged in increasingly aggressive competition on each other’s turf. On the flip side smaller markets in EMEA generally added value, as did our overweight exposure to Korea.
During the quarter we have continued adding to Korea as the market is finally seeing tailwinds from value-up and a return of political stability. We have also been building some more exposure to India although remaining very much underweight on valuations and have re-entered Malaysia which is increasingly attractive in the South-East Asian context. These have been funded by taking profits on stocks in China, Taiwan, Poland and the UAE. We have trimmed the TWD forward hedges and will continue to reassess whether they remain attractive from a risk-adjusted perspective. Historically they have provided positive carry with low volatility and a free tail hedge for geopolitical risks.
The past quarter provided evidence that many long-held certainties and correlations need to be reassessed. Most centrally, the behaviour of the US dollar is leading currency traders to tear their hair out. The reaction of oil prices to US bombing of Iran or the schizophrenic moves in US bond markets relative to the deficit busting bills have also been defying conventional wisdom. The long-standing expectation that the Taiwanese central bank would minimize volatility in its semi-managed currency has also been severely undermined with unprecedented daily moves of 4%+ in the currency.
While the Taiwan dollar (TWD) has experienced various periods of gradual strengthening and weakening, this was a slow process. As a result, important parts of the island’s insurance industry were premised on relatively low volatility. Domestic insurance companies have typically held higher yielding US dollar assets to provide sufficient returns on their liabilities. Large parts of this exposure were unhedged with an effective central bank “put” in place on any TWD strengthening. Conventional wisdom was that in the new tariff world, the currency would likely weaken, in order to compensate for tariffs. In recent months, the realization that an appreciation of the TWD might form part of tariff negotiations with the US led to panic repatriation and hedging of Taiwanese insurance holdings and a self-fulfilling cycle of TWD strengthening. The stress in the system can be measured by the level of premium that one-year TWD forwards trade at – currently close to 7%.
In hindsight the risk of TWD following all other global currencies upwards against a weaker dollar was obvious. Going forward, there is some nuance to the outlook. The central bank is watching insurance company balance sheets closely – they will be reporting significant losses on their holdings in Q2 although mostly remain solvent. Their ongoing balance sheet restructuring process is keeping up the pressure on the currency and forward markets, partly offset by central bank intervention when needed. Given the risk to the financial system, we are not likely to see further sudden moves but for there is scope for TWD to remain well bid. As desperation hedging fades away, the forward premiums should also start compressing back towards historic levels of 3-4%.
Curiously, Taiwanese exporters that typically price in USD have continued reporting strong sales even when translated back into TWD. This may reflect continued front-loading ahead of tariffs by buyers but may also show the pricing power exhibited by Taiwanese businesses that are looking to protect their margins and top line. Because USD weakness is universal, the currency appreciation doesn’t put Taiwan at a disadvantage to its Asian peers and in many cases, they enjoy near monopolistic positions.
