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Perspectives on the China-Taiwan Conflict

Recently, the conflict between China and Taiwan has come to a head. From an investor's point of view, the possible further escalation of this conflict represents one of the greatest risks for an investment in China. We would like to shed light on the conflict, and the possible impact on investments and strategy adjustments to our fund.

Unstable Status Quo The "status quo" of recent years, namely China's proclamation that Taiwan belongs to China, the non-recognition of Taiwan as an independent country by most countries in the world, and an established democracy in Taiwan, represented an acceptable but unstable balance. Chinese military activities near Taiwan, US arms shipments to Taiwan, and Nancy Pelosi's visit to Taiwan all escalated the situation.

China has now described its "red lines" in an official "white paper". Should these red lines, such as a declaration of independence by Taiwan, or official recognition of Taiwan by the West as an independent state, be crossed, we believe there will be further escalations. If these red lines are not crossed, we do not see any major danger of a military conflict in the short or medium term. China has three overarching goals: world market leadership, social peace in the country, and complete technological and economic independence from other countries. A war with Taiwan would jeopardize the achievement of these goals. The West's unified stance, including economic sanctions against Russia, certainly helped here as well.

Accordingly, we see the risk of a short- or medium-term warlike escalation as low. Nevertheless, we would like to shed light on such an "escalation scenario" and describe a corresponding response from the fund.

Significant geopolitical and economic consequences of an escalation If the situation between China and Taiwan should actually escalate, there would be significant geopolitical and economic consequences for the Asian region and for the entire world.

Although Ukraine and Taiwan are not really comparable, as Ukraine is a legally recognized country and Taiwan is not, the “West” would support Taiwan and there would be massive sanctions against China. The hardening of the camps “China-Russia” versus the “West” would be accelerated. However, as in the Ukraine conflict, this would not necessarily lead to other countries in Asia, Africa, South America and Eastern Europe distancing themselves from China. A similar situation as with the Russia sanctions would probably arise. The West pays and many other countries in the world benefit, such as India and China who simply buy cheaper oil and gas after the sanctions against Russia .

The economic consequences for the Asian region outside of China will probably be limited. As the Asian countries would almost certainly not join the western sanctions, China's trade in the Asian region would hardly be affected.

The extent to which economic relations between China and the rest of the western world would suffer depends on the intensity of the sanctions. China is a sales market and a supplier market. In the event of a war, both markets would collapse, with major repercussions for China and for all those opposed to China. 1/3 of all products worldwide come from China, and DAX companies have a sales share of 18% in China.

For a large part of the German industry, with the German car manufacturers and the German semiconductor customers of Taiwanese companies, China sanctions as we have seen in Russia, would be a dramatic, and even life-threatening turning point. Companies like Volkswagen, BASF and Adidas, which generate a large part of their sales and profits in China, would suffer dramatically. Overall, it must be assumed that the effects on the world economy and world capital markets will be far more dramatic than we are currently experiencing in the case of Russia.

The Special Importance of Taiwan's Semiconductor Industry Aside from the outstanding political, ideologically driven dimension of the Taiwan issue, the Taiwanese chip industry is of course the jewel of Taiwan for China. Taiwan's chip industry, above all the Taiwan Semiconductor Manufacturing Company (TSMC), is the world market leader and accounts for approximately two-thirds of global semiconductor contract manufacturing. Taiwanese chips are now installed in an infinite number of electronic components worldwide and the West has neither the capacity nor the ability to compensate for this in the short and medium-term. China's semiconductor industry, on the other hand, continues to lag behind despite multi-billion investment in semiconductors.

If Taiwan were to be taken over, China would take a huge step forward in the semiconductor industry in one fell swoop. It is therefore not to be expected that China will shut down the Taiwanese chip industry in the event of a military takeover. On the contrary, it can be expected that China will fully utilize the Taiwanese chip industry and use it to its advantage.

China's "competitiveness" would be significantly strengthened and the West paralyzed at least in the medium-term. Despite the efforts of the USA and Europe to become more independent from Asia for semiconductors, we are still light years away from being so. Companies like Apple, which depend on Taiwanese chip supplies, would experience a dramatic collapse in both the business and the capital market. If that happens, the current Russia gas crisis will be eclipsed as the implications for the West could be far more dramatic.

Significant impact on the capital market In the "escalation scenario", there will also be a dramatic global impact on the capital markets. It can be expected that Western investors will significantly reduce their investments in China and probably also in Asia. The dwindling demand, as we have also seen over the past 18 months, will lead to significant price losses for many Chinese, Asian and also global stocks. But there will also be big winners in this scenario.

Winners will be countries like South Korea, Japan and India, which will continue to do business with the US, and those countries that won't oppose China, such as Indonesia, Thailand and Singapore.

First and foremost, we would see the South Korean semiconductor industry thriving, for example. Many TSMC customers would look for alternatives as quickly as possible and thus be driven into the arms of companies such as Samsung and Hynix.

Our fund is liquid on a daily basis. We can withdraw the entire China investment at short notice. In the escalation scenario, we would significantly reduce our China exposure and significantly increase our exposure to the Asian “winners” of this scenario.

In summary, we would like to state that we assess the risk of a short or medium-term military escalation as low. Should such an escalation nevertheless occur, we would reallocate the portfolio to the "winners" of such a scenario.

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