Semiconductors have been Wall Street's hottest investment for more than three years now. And the hottest exchange-traded fund (ETF) in this space is the VanEck Semiconductor ETF (SMH 0.15%). With a three-year total return of more than 350%, it's been the best-performing non-leveraged ETF in this category (and by a fair margin).
The reason for the outperformance has been the absolute boom in megacap chipmakers. Nvidia, Taiwan Semiconductor Manufacturing, and Broadcom led the sector higher out of the gate, but now the next tier of names, including Lam Research, ASML, and Applied Materials, are starting to catch up.
In its very early stages, the artificial intelligence (AI) story centered around Nvidia. Today, it's an industrywide growth story. Current forecasts call for nearly $1 trillion in annual sales. By 2036, that number is expected to double to $2 trillion. While there is likely to be a growth slowdown sometime in the next several years, it doesn't look like it's going to happen anytime soon.
After the initial hype rally, semiconductor companies are again trading on earnings and financial results. Given the sector's current trajectory, the VanEck Semiconductor ETF is a buy.
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How the VanEck Semiconductor ETF (SMH) is constructed
This ETF tracks the MVIS US Listed Semiconductor 25 Index, a market-cap-weighted portfolio of roughly two dozen semiconductor stocks. That can include chip designers, foundries, memory manufacturers, and equipment builders.
NASDAQ: SMH
Key Data Points
The market cap weighting strategy is a key differentiator. It assigns the highest weightings to the sector's largest companies. That means it's very top-heavy, with a large percentage of the portfolio invested in just a handful of companies.
Current top holdings include Nvidia (16%), TSMC (9%), Intel (8%), and Advanced Micro Devices (7%). That means the VanEck Semiconductor ETF performs best when the industry's leaders perform best.
The State Street SPDR S&P Semiconductor ETF (XSD 2.78%), for example, uses an equal-weight strategy instead. That tends to provide more diversified exposure to the sector, but it can also potentially water down returns when the industry heavyweights are leading the way. It's a trade-off depending on what you're looking for in your portfolio. But given how well the largest companies have fared in the AI build-out thus far, it's fair to think that they'll be the drivers in the future as well.
SMH is well-positioned for the next several years
If you're looking to build a position in semiconductor stocks, the VanEck Semiconductor ETF is the one I'd choose.
The non-megacap names have been making good progress lately on their build-outs and stock performance. But I believe the leaders are ready to recapture leadership.
If current demand expectations become reality, this fund's structure allocates the largest shares to companies positioned to benefit the most.
