Taiwan Semiconductor Manufacturing's (TSM) share price in Taipei has surged 36% year-to-date, driving its weighting in the Taiwan Stock Exchange Weighted Index to nearly 43%. The chipmaker now also accounts for a record 12% of both the MSCI Emerging Markets Index and MSCI Asia ex-Japan Index.

However, this dominance has created challenges for active funds with over $100 billion in assets benchmarked to MSCI indices. Due to EU's UCITS rules and Taiwan's local regulations that typically cap single-stock holdings at 10% of net asset value, these funds cannot fully allocate to TSM, exposing them to significant underperformance risks. Passive index funds generally face fewer constraints in matching benchmark weights.

"We persistently underweight Taiwan Semiconductor Manufacturing not by investment conviction but due to structural limitations," said Roxy Wong, senior portfolio manager at BNP Paribas Asset Management. "The real risk for us lies in the underweight position itself."

Some fund managers have turned to investing in companies like Hon Hai Precision or ASE Technology Holding, seen as part of TSM's value chain, or using derivatives for hedging. However, such strategies have clear limitations.

"Managing such large index constituent risk is highly challenging for portfolio managers," noted John Tsai, portfolio manager at Eastspring Investments.

Analysts point out that while alternative plays may benefit from the same AI-driven tailwinds, they cannot replicate TSM's superior pricing power, earnings quality, or business resilience derived from its leadership in cutting-edge chip manufacturing.

As Wong emphasized, finding a proxy that replicates TSM's market position, growth trajectory, and stability combination remains extremely difficult.