How to Choose a Semiconductor ETF
Thrive Portfolios, Inc.
Thrive Portfolios is a purpose-driven Investment Advisory firm that helps our people and our planet.
Where do you invest new money in today’s market? I have some clients that are receiving their annual bonuses and are asking how I will invest it for them. The S&P 500, investment-grade bonds, individual equities and/or Nvidia? I’d have some concerns with each of those choices.
I am most drawn to the semiconductor industry. It is at the heart of a global industrial war and the world’s largest countries are pouring billions of dollars into semiconductor companies. The U.S. is providing $53B and China is providing $142B in stimulus to the semiconductor industry. Each country is building out more capacity while restricting the other from access to their technologies. The Wall Street Journal is reporting that the semiconductor industry is expected to double by the end of the decade to $1 trillion.
We can access the semiconductor industry with relative safety by investing in Exchange Traded Funds. ETF’s provide opportunities to own broad swaths of this industry without needing to understand the nuances of a very technical product.
It is important to know what you’re looking for. Do you want to trade or invest? Is your investment style more conservative or do you seek leverage? Are you more comfortable with equal-weighted holdings or concentrated positions within an ETF? I intend to simplify these decisions for you.
I’ve whittled the universe down to the 4 largest semiconductor ETF’s. Three of the four charge the same Expense Ratio. I think 35bps is reasonable for a themed and unleveraged ETF. The fourth is SOXL, it is leveraged and charges 76bps.
We look at Total Assets and Avg Daily Volume to ensure there is liquidity. When a fund doesn’t have enough liquidity, an investor might sacrifice on price when exiting the trade. On the institutional side, we can engage with market makers and shop around for prices that are not public knowledge. We can communicate our intentions hours or days before placing a large trade. This contingency plan is not available to retail traders/investors, making liquidity a very important consideration.
?Next, we look at historical performance for more insights. We’re not going to chase past performance, but it can help us identify structural nuances. Why do SMH, SOXX, and XSD have drastically different performance? It is very common for similar ETF’s to track completely different benchmark indices. We know SOXL is structurally different because it is leveraged.
Side Note: SOXX and SOXL are not managed by the same company. SOXX is managed by iShares and SOXL is managed by Direxion. They are unrelated except for the ticker symbols’ clever word play on the original semiconductor index, “The SOX”, or the Philadelphia Semiconductor Index.
?It is absolutely critical to always “look under the hood” at the holdings of any fund before trading it or investing in it. Here are the Top 10 Holdings of each ETF we are examining:
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I’ll rule out SOXL, because leveraged ETF’s are better suited for trading than investing. The current opportunity in semiconductors is a long-term investable trend. It takes time and billions of dollars to build semiconductor fabrication plants. For example, Taiwan Semi is spending $40B on a new fabrication plant in Phoenix, AZ. Intel is spending $43.5B on three new fabrication plants in AZ, OH and NM.
The other three ETF’s (SMH, SOXX and XSD) share the same Expense Ratio. I’m comfortable with the Total Assets (size) and Avg Daily Volume (liquidity) of SMH and SOXX. With those two good options, I don’t need to take size and liquidity risk with XSD. I also don’t prefer the holdings in the index that XSD tracks, the S&P Semiconductor Select Industry Index. I feel like SMH is too concentrated in its largest holdings, with 36.23% combined between NVDA and TSM. I would rather buy shares of NVDA and TSM if 36.23% of my performance is dictated by them in SMH. In contrast, SOXX has 14.32% exposure to NVDA and TSM.
For my money, SOXX is a clear winner for investing in the long-term trend in the Semiconductor industry. I like the holdings, the weighting of the holdings, the expense ratio, the size of the fund, and its liquidity.
Happy Investing,