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Semiconductor ETF Investing 101

The Semiconductor Industry serves as a driver, enabler and indicator of technological progress. As environmental issues have become more of a concern today, semiconductor devices are being made to reduce power consumption, reduce heat dissipation, capture solar energy, create more efficient lighting solutions and so forth.

Manufacturing operations have shifted to Asia over the past decade, but since innovation remains largely within the country, the sector is one of the biggest employers of labor, with a corresponding significant impact on the overall economy.

The consumer and computing markets consume two-thirds of all semiconductors, which are increasing convergence between these two markets such that it is getting more difficult to identify which devices are computing and which consumer. (Read: Tech ETFs to benefit most on Apple’s Earnings Beat)

PC market growth will be moderate in the next few years, more than made up by growth in mobile devices. Semiconductors for mobile devices have their own set of unique challenges: greater functionality and better experience at higher speeds and consuming less power. They also have to be priced lower. Additionally, a lot of the growth in the next few years will come from price-sensitive emerging markets, which is likely to pressure margins for players.

Spending on consumer electronics is not expected to be more than 2.0% this year (previous forecast of 2.4% was adjusted due to better-than-expected 2013 growth) and 1.2% in 2015. Unsurprisingly, emerging product categories like 3D printers, health and fitness devices, smart watches, Ultra HD television displays and smart thermostats will see the strongest growth (242%), albeit off a small base. Smartphone revenue (the single largest driver of CE sales) will grow 7% while tablets will see a 3% decline, according to the CEA.

The move to cloud computing and growing data consumption on mobile devices is leading to strong demand for suitable wireless and computing networks. This is currently one of the most important semiconductor markets. Industrial automation, automotive, aerospace and defense are also consuming a growing number of semiconductors, but auto is currently expected to be the strongest of these driven by infotainment and safety.

The next growth wave will undoubtedly come from the Internet of Things, a market that IDC expects to grow at a CAGR of 7.9% through 2020. Semiconductors will play an important role enabling this transition, leading to tremendous growth in the segment. (Read: Semiconductor ETFs in focus after Friday’s Rout)

Forecast for 2014

According to World Semiconductor Trade Statistics (:WSTS) data, there should be positive worldwide semiconductor sales growth of 6.5% in 2014 (previous 4.1%), followed by 3.3% growth in 2015 (previous 3.4%). Asia, Europe and the Americas will grow 9.3%, 7.9% and 2.1%, respectively. Japan is will be down 1.3%. The SIA didn’t provide an end-market wise update. It previously expected growth across markets in both years, although wireless and automotive were expected to grow the strongest with consumer and computing staying relatively stable.

Playing the Sector Through ETFs

The ongoing transition across multiple served markets makes it difficult to select winning semiconductor stocks. However, companies in charge of core manufacturing generally gain whenever there is market growth. As a result, it could be easier to play the sector through ETFs that are more heavily weighted to these big players. (See all technology ETFs here)

Here are a few ETFs tracking the industry, any of which could be interesting picks:

Van Eck Market Vectors Semiconductor ETF (SMH)

The Van Eck Market Vectors Semiconductor ETF was started in 1955 to replicate the price and yield performance of the Market Vectors U.S. Listed Semiconductor 25 Index.

This Index tracks the overall performance of 25 of the largest U.S. listed, publicly-traded semiconductor companies. Some of the largest holdings include Intel Corp (INTC), Taiwan Semiconductor Manufacturing Company (TSM) and Texas Instruments (TXN). Its expense ratio is 0.35% and its dividend yields 1.31%.

iShares PHLX Semiconductor ETF (SOXX)

Founded in 2001, the iShares PHLX Semiconductor ETF is based on U.S.-listed semiconductor stocks represented by the PHLX Semiconductor Sector Index.

The top holdings in the ETF include Texas Instruments, Intel Corp, Qualcomm Inc (QCOM) and Applied Materials (AMAT). Its expense ratio is 0.48% and its dividend yields 1.09%. Net assets on Oct 6, 2014 were $525.1 million.

SPDR S&P Semiconductor ETF (XSD)

Founded in 2006, the SPDR S&P Semiconductor ETF tracks the S&P Semiconductor Select Industry Index. This is an equal-weighted ETF comprising 49 stocks with an expense ratio of 0.35% and a dividend yield of 0.49%.

Powershares Dynamic Semiconductors ETF (PSI)

The Powershares Dynamic Semiconductors ETF was started in 2005 to track the performance of the Dynamic Semiconductors Intellidex Index. At least 90% of its assets are invested in stocks that comprise the Index. Its top holdings include Micron Technology, Applied Materials and KLA-Tencor. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November. Its expense ratio is 0.63% and the dividend yields 0.49%.

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