ETFs
The VanEck Semiconductor ETF is riskier than you think
There should be no doubt about the investment objective of VanEck Semiconductor ETF (NASDAQ:SMH). As its name clearly indicates, it invests in the semiconductor sector. So, by design, it is not a particularly diversified exchange-traded fund (ETF), which creates investment risk to consider in any purchasing decision.
But don’t stop there: there’s another diversification issue you need to consider.
What does the VanEck Semiconductor ETF do?
As already noted, VanEck Semiconductor ETF does exactly what its name suggests and tracks the semiconductor sector. THE exchange traded fund follows the MVIS U.S. Listed Semiconductor 25. According to thematic market indexer Market Vector, this index “tracks the performance of the 25 largest and most liquid U.S. publicly traded companies in the semiconductor industry. It is a modified market capitalization-weighted index and only includes companies that generate at least 50% of their revenue from semiconductors or semiconductor equipment.
Image source: Getty Images.
In other words, the VanEck Semiconductor ETF is designed to hold just 25 stocks. All shares in the ETF primarily generate income from semiconductors. They also happen to be all important, which indirectly suggests that they are popular titles. There is another important feature: a modified market cap weighting that caps the largest stocks at 20% of the ETF’s assets. So not only are the fund’s stocks the largest semiconductor companies, but the largest of the largest also receive the highest weighting in the portfolio.
The ETF’s expense ratio is 0.35%, which is high compared to a broad-based ETF like SPDR S&P 500 ETF Trustof the expense ratio of 0.09%, but it is in line with that of its direct peers SPDR S&P Semiconductor ETF (NYSEMKT:XSD). The fund is therefore inexpensive to own, but not as cheap as other less focused ETFs.
Diversification is the VanEck Semiconductor ETF’s problem
To be honest, if you’re buying a VanEck Semiconductor ETF, you’re probably not looking for a very diversified ETF. And you’re probably willing to accept a slightly higher cost of ownership to have direct exposure to the semiconductor industry. But don’t stop at the highest level here; just dig a little deeper.
When you look at the list of VanEck Semiconductor ETF holdings, there are some weightings that are concerning. To begin with, sweetheart of the market Nvidia (NASDAQ: NVDA) currently represents just over 23% of the portfolio even though the cap is set at 20%. In fact, the portfolio is only rebalanced quarterly. Thus, between rebalancing dates, the weightings can (and do) become unbalanced. The second largest holding is Semiconductor manufacturing in Taiwan (NYSE: TSM) at just over 12%. This means that the ups and downs of Nvidia’s stock will have a disproportionate impact on the ETF’s performance.
The story continues
NVDA Chart
That said, the ETF’s top five stocks (Nvidia, TSMC, Broadcom, QualcommAnd Texas Instruments) represent a little more than 50% of the assets. This represents a huge weighting in a very small number of stocks. This is a fund concentrated in a single sector and then also concentrated in that sector. As the chart above shows, four of the top five stocks significantly outperformed the S&P500 index over the past year. But when the sector calms down, the decline could be quite painful.
CSCO Chart
But the biggest number on the semiconductor stock chart is Nvidia, which has gained an incredible 190% in one year! Wall Street seems to believe Nvidia can defy gravity, but a quick look back at Cisco Systems The dot-com bubble should remind us that the hottest stocks usually come back down to earth. Indeed, Cisco stock has still not regained all the ground lost after its disgrace. Given the VanEck Semiconductor ETF’s large position in Nvidia, the ETF potentially exposes investors to a similar fate.
How much exposure do you really want?
Being exposed to hot, rising stocks is exciting, but you need to understand the risks. Yes, the VanEck Semiconductor ETF offers a little diversification in the semiconductor sector, but not much. This is the type of ETF that only the most aggressive investors should own and only if they have very strong feelings about semiconductor stocks (and specifically Nvidia). Most would probably be better off with a more broadly diversified tech ETF.
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Ruben Gregg Brewer holds positions at Texas Instruments. The Motley Fool holds positions and recommends Cisco Systems, Nvidia, Qualcomm, Taiwan Semiconductor Manufacturing and Texas Instruments. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
The VanEck Semiconductor ETF is riskier than you think was originally published by The Motley Fool