By Robert Goldsborough
In recent months, the semiconductor sector has come under
pressure. Investors have soured on chipmakers amid softening demand
that has been caused by continued uncertainty in Europe and a
less-than-stellar personal-computer market. The entire sector has
fallen by 13% in the past three months, driving down
exchange-traded funds that track the semiconductor industry.
For a contrarian investor, however, the time to consider
investing may be approaching. Earnings reports are just around the
corner, and whether chipmakers disappoint or not, industry players
will at least clear up some level of uncertainty. And there are
good reasons to expect a longer-term rebound for the sector.
Although the PC end market may well be stalled, the industry stands
to continue to benefit from the new releases of a wide variety of
technology products, such as Apple's (
) new iPhone and computer hardware makers' new Ultrabook
innovation. Also, as the economy continues its long slog toward
recovery, we expect corporate spending on IT--and especially on
data center technology and networking infrastructure, both of which
need semiconductors--to remain strong.
Market Vectors Semiconductor ETF
) as the most appropriate way to tap into the semiconductor market.
The fund holds 25 of the largest semiconductor players, has an
attractive 0.35% price tag (tied for the lowest relative to all of
its peers), and trades at a compelling 85% of its fair value. By
comparison, other broad-based tech ETFs are not trading at such
discounts, nor is the broader market as a whole. For example, SPDR
S&P 500 (
) trades at 89% of fair value, while Technology Select Sector SPDR
) trades at 89% of fair value, Fidelity Nasdaq Composite Index
) trades at 92% of fair value, and PowerShares QQQ (QQQ) trades at
89% of fair value.
As a subsector-specific ETF, SMH invests in semiconductor firms and
semiconductor capital equipment firms and should be viewed as a
tactical investment, suitable only as a complementary satellite
holding to a diversified portfolio. Because of its narrow sector
focus, this ETF lacks the diversification of broader funds.
Semiconductor firms are more cyclical and more volatile than
other kinds of tech companies. SMH's narrow industry focus means
there is little overlap with broad market ETFs--semiconductor firms
make up 1.8% of SPDR S&P 500 and 9.6% of the tech-heavy
While the semiconductor industry may be heading into a bit of a
rough patch right now, over the longer term we are not worried
about demand in the semiconductor space; often, chip downturns
simply are reflections of just how cyclical the semiconductor
industry is. For example, some customers have drawn down
inventories on fears that current turbulence in the financial
markets could hamper sales. And a variety of one-time events have
caused problems as well, such as flooding in Thailand (which has
hampered hard-disk-drive production and disrupted the PC-supply
Because the semiconductor industry is very cyclical, investors
may find it useful to follow some industry metrics. The
Industry Association's website
provides industry data and releases a three-month average of global
semiconductor sales around the first of every month. The SIA
reported that industry sales grew in the low single digits in 2011,
driven by demand in tablets and PCs, and the association forecasts
further improvement in 2012. Through the first quarter of 2012,
sequential sales growth had taken place across all regions, with
association officials projecting momentum to build throughout the
Generally speaking, the trends in monthly sales tend to lag the
price performance of semiconductor stocks, but historical data can
help provide some perspective on the current cycle. A somewhat more
prospective data point could be the three-month moving average of
orders to North American semiconductor equipment firms (these firms
sell manufacturing equipment and tools to semiconductor companies)
and a book/bill ratio, which can be
found at semi.org
. A book/bill ratio higher than 1 implies that recent new orders
are outpacing current shipments, which would suggest that
semiconductor companies are optimistic about near-term demand. As
of this writing, the industry's book/bill ratio has slid a bit in
recent months. However, the book/bill ratio still points to overall
optimism for the sector, as it remains above 1.0. The May 2012
book/bill ratio was 1.05, down slightly from 1.10 in April 2012 and
a high-water mark of 1.12 in March 2012.
This ETF employs full replication to track a
market-capitalization-weighted, rules-based index of the 25 largest
U.S. listed, publicly traded semiconductor and
semiconductor-equipment companies. This ETF is fairly concentrated,
with the top five holdings comprising just more than 50% of assets,
and the top 10 holdings making up more than 71% of assets. This is
a very high-quality portfolio. Almost 33% of this ETF's assets are
invested in companies with wide economic moats, with another 51.5%
invested in firms with narrow moats. About 72% of the assets in
this ETF are invested in companies based in the United States
(although all of this ETF's holdings trade in the U.S.). The
remaining assets are invested in firms domiciled in Taiwan (13% of
this ETF's assets), the Netherlands (5%), the United Kingdom (4%),
Singapore (3%), and Bermuda (2%).
This ETF charges 0.35%, which we consider to be a reasonable fee
for a subsector-level fund. The fee is identical to the expense
ratio charged by the semiconductor ETF SPDR S&P Semiconductor
(XSD). The other two semiconductor ETFs charge more.
SMH is the largest and most liquid semiconductor ETF. However,
investors seeking semiconductor exposure have three other ETF
options. A slightly more expensive and less liquid option is
iShares PHLX SOX Semiconductor Sector (SOXX), which charges 0.48%
and holds 30 companies. Like SMH, SOXX is a market-cap-weighted
ETF. While SOXX has a higher price tag and is less liquid, it also
holds companies that are slightly more undervalued. At present,
SOXX trades at 83% of its fair value.
Another option is SPDR S&P Semiconductor ETF (XSD), which
charges 0.35%. XSD holds 48 semiconductor companies that it equally
weights, so its portfolio tilts more toward small- and mid-cap
stocks than does the iShares offering.
Still another possibility is PowerShares Dynamic Semiconductors
(PSI) (0.63% expense ratio), which is a 30-stock portfolio with
weightings based on the dynamic Intellidex methodology.
Investors seeking broader technology-sector exposure can
consider Technology Select Sector SPDR (0.18% expense ratio) and
Vanguard Information Technology ETF (VGT) (0.19% expense ratio).
The two funds are almost perfectly correlated.
Morningstar licenses its indexes to certain ETF and ETN providers,
including BlackRock, Invesco, Merrill Lynch, Northern Trust, and
Scottrade for use in exchange-traded funds and notes. These ETFs
and ETNs are not sponsored, issued, or sold by Morningstar.
Morningstar does not make any representation regarding the
advisability of investing in ETFs or ETNs that are based on
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