Is Fabless the sweet spot?

Is Fabless the sweet spot for semiconductors?

All areas of the semiconductor ecosystem have huge barriers to entry based on patents, intellectual property and billions of dollars of capital spending – an increasingly various sanctions and trade restrictions - but share price returns for different specialities diverge widely. Some semiconductor ETFs cover the whole space while others focus on one stage of the value chain.

The biggest players in manufacturing are Taiwan’s TSMC and South Korea’s Samsung, which own enormous fabrication plants or “fabs”, and are up about 70% and 10% over the past year. They use hyper-specialised and ultra-precise equipment, manufactured by the Netherlands’ ASML and US firm, Lam Research, which are up around 30% and 17% respectively over the last year. But it is the fab-less architects of semiconductor design, led by Nvidia, up by 157% over the last year, that have been generating the best share price returns for several years. 

VanEck Fabless Semiconductor ETF (SMHX) drills down its focus into US-listed fabless firms, which have greatly outperformed the overall semiconductor sector since at least 2021. Since September 2021, the BlueStar Top 10 US Listed Fabless Semis index is up over 100% against only about 50% for NASDAQ Global Semiconductor index and just 30% for the Nasdaq 100.

SMHX tracks the MarketVector^™ US Listed Fabless Semiconductor Index. Its top ten holdings contain three very familiar names: Nvidia (which is close to the 20% maximum per company for this index), Broadcom and Advanced Micro Devices, all of which are Nasdaq 100 members. The index top ten also includes some less well-known names: Monolithic Power Systems, Qualcomm, Impinj, Cirrus Logic, Marvell Technology, Synopsys and Cadence Design Systems. 

All index members unsurprisingly belong to the information technology sector. Some 75% of the index is in large caps or mega caps, above USD 6 billion. Currently 10 names making up 23% of the index are in “mid caps”, defined as market caps between USD 1.5 and USD 6 billion, and there is even one “small cap”, defined as between USD 200 million and USD 1.5 billion. The minimum market cap for the index is only USD 150 million, which means it could in theory hold some names that meet the US definition of a “microcap”. Thus SMHX can fish amongst the minnows and might perhaps find the next Nvidia. First listing in 1999, Nvidia ten-bagged its way into the Nasdaq 100 by 2001 and has been roughly a 3,000-bagger from the start.

SMHX’s expense ratio of 0.35% is the same as on VanEck’s existing semiconductor ETF, SMH, which launched in 2020. iShares’ semis ETF, SOXX, also charges 0.35%. It seems that the price war in fees has not really reached sector specialist and thematic ETFs and anyway investors and traders in these are mainly focused on performance.

SOXX runs USD 2 billion, less than SMH’s USD 2.5 billion. Though iShares’ total ETF AUM over 3 trillion is over 30 times greater than VanEck’s ETF assets, VanEck has carved out a niche in creating sector specialist thematic products that appeal to investors.