TXN - XSD: 'Xtra' Semiconductor Diversification

Summary

• Following my "Pursuing Semiconductors Intelligently" article on the PSI ETF, today, I'm covering a better (and lower-cost) performing semiconductor ETF - the XSD.
• The SPDR S&P Semiconductor ETF holds heavier weightings in relatively smaller semiconductor companies as compared to the PSI, SMH, and SOXX ETFs.
• XSD has an expense fee of 0.35% and spectacular 10-year average annual return of 24.3%.
• That being the case, any investor wanting diversified exposure to the semiconductor sector should give serious consideration to owning the XSD ETF.

Lately, I have been crafting Seeking Alpha titles for my ETF articles based on the first letters of the symbol (thus the misspelling of "Extra," please forgive). The reason I chose "Xtra Semiconductor Diversification" for the SPDR S&P Semiconductor ETF ( XSD ) is because its portfolio is more heavily weighted to some of the smaller semiconductor companies as compared to the typical semiconductor funds like the [[SMH]], [[PSI]], and [[SOXX]] ETFs. One reason for XSD's out-performance over the years is likely because these smaller companies are growing faster than the larger and more familiar names in the industry. That being the case, today I'm going to take a closer look at the XSD ETF to see if it might be worthy of an allocation of capital within your well-diversified portfolio. After all, and despite the bear market mauling last year, the XSD semiconductor ETF has a long history of significantly outperforming the broad market averages as represented by the SPDR DJIA ETF ( DIA ), the Vanguard S&P500 ETF ( VOO ), and Nasdaq-100 ETF ( QQQ ):

Investment Thesis

One reason that the semiconductor sector has been such a high-performing sector in the United States markets is because it's fast growing and has become a critical source of exports. Indeed, as reported by the Semiconductor Industry Association ("SIA"), and despite the fact that total domestic semiconductor manufacturing capacity has slipped over the past few decades, the U.S. semiconductor industry has a dominant global market share (46%) and has become a huge economic force:

I was quite surprised that U.S. semiconductors are now the #5 export after planes and energy (refined product, oil, and natural gas). From that perspective, and if we lump all petroleum products into a single "energy" category, semiconductors are - in effect - the U.S.'s #3 largest source of export revenues.

Meantime, these semiconductor exports are benefiting from fast-growing global growth in a long-list of expanding semiconductor use cases: EVs, high-speed networking, IoT, 5G smartphones and infrastructure, data center, high-performance computing ("HPC"), the cloud, and application specific hardware accelerators to run optimized AI and ML algorithms on mega-data sets - just to name a few. That being the case, let's take a closer look at the XSD ETF to see how it has positioned investors to succeed moving forward.

Top-10 Holdings

The top-10 holdings in the XSD ETF are shown below and were taken directly from the State Street Global Advisors' XSD ETF homepage , where you can find additional details on the fund. The top-10 holdings equate to what I consider to be a well-diversified 31% of the entire 39-company portfolio:

My first observation is that all top-10 holdings have a relatively equal weight. My second observation is that many of the big companies you are likely to easily recognize in the semiconductor sector are well down the list of holdings. For example, Texas Instruments ( TXN ) and Intel ( INTC ) are the #29 and #30 holding, with each having only a ~2.5% weight. As mentioned earlier, this is the primary reason that - generally - the XSD ETF has a relatively higher weighting in some of the smaller semiconductor companies.

A prime example is the #1 holding with a 3.35% weight: Cirrus Logic ( CRUS ). Cirrus has a market-cap of only $5.9 billion (TXN's is $166 billion) that specializes in low-power, high-precision mixed-signal processing chips like DACs and ADCs (digital-to-analog converters and analog-to-digital converters). Cirrus' recent Q3 FY23 earnings report was a top- and bottom line beat: non-GAAP EPS of $2.40 beat consensus estimates by $0.41 , while revenue of $590.6 million (+7.7% yoy) beat by $47.05 million. Cirrus is up 28% over the past year and trades with a forward P/E of 16.8x.

Allegro MicroSystems ( ALGM ) is the #2 holding with a 3.2% weight. ALGM is up a whopping 46% YTD. The company designs application-specific analog power ICs for motion control and energy-efficient systems, magnetic sensor ICs to determine position and speed; current sensor ICs, power ICs for electric motor drivers, and photonic and 3D sensing components - including photodiodes and eye-safe lasers. Allegro also makes readout ICs for LiDAR applications. In a November Investor Presentation , investors can see that Allegro is killing it in the EV market while its Automotive Segment in general equates to the majority of its revenue:

Skyworks Solutions ( SWKS ) is the #4 holding with a 3.1% weight. The stock of Skyworks - a company that designs chips for the smartphone and mobile markets, among others - is down 11% over the past year. However, the company recently announced a $2 billion buyback plan that recently put pep-in-the-step of the shares.

The #7 holding with a 3.0% weight is AMD ( AMD ). AMD released its Q4 and full-year 2002 earnings report a couple weeks ago and it was stronger than expected:

Revenue of $5.6 billion increased 16% yoy and was driven by growth across the Embedded (i.e. the Xilinx acquisition) and Data Center segments. That strength was partially offset by lower Client and Gaming segment revenue. The quarterly loss was primarily due to costs associated with the Xilinx acquisition. AMD stock is up 34% YTD and trades with a forward P/E of 28x.

The top-10 is rounded out by Credo Technology ( CRDO ). Credo specializes in high-speed connectivity solutions for the global optical and ethernet markets. The company produces SerDes chiplets - which are serializer/deserializer circuits and the accompanying DSPs (digital signal processors). The company also licenses its SerDes IP technology. Credo stock is +32.6% over the past year and trades at a rich valuation of 133x forward earnings.

Performance

As mentioned earlier, the XSD has an outstanding long-term performance track record - with a 10-year average annual returns of a sparkling 24%+:

The graphic below compares five-year total returns of the XSD ETF against a few of its main competitors: the VanEck Semiconductor ETF ( SMH ), the Invesco Dynamic Semiconductor ETF ( PSI ), and the iShares Semiconductor ETF ( SOXX ):

As can be seen, the XSD is far-n-away the best performer of the group.

Risks

In my opinion, over the long term the XSD ETF is likely to continue out-performing the broad semiconductor sector and to significantly outperform the broad market averages (as it has done in the past). However, in the short term the fund may be overbought. I say that because since the beginning of the year the XSD ETF is up a whopping 25.8%. That being the case, I advise new investors in the fund to initiate a small position and add to it over time. Do not rush in - or feel the need to go "all-in" - here.

Rising U.S. interest rates are a threat because it would cause the U.S. dollar index to rise, and be a foreign currency headwind to many of the companies in the XSD portfolio that get a large proportion of revenue from overseas.

Due to its generally smaller market-cap holdings profile, XSD is a more volatile fund as compared to some of the other alternatives in semiconductor ETF space. However, investors can't argue with the XSD ETF's long-term performance track-record and can use the volatility to buy on dips.

Summary and Conclusion

The XSD ETF is an excellent semiconductor ETF to own if you are overweight the bigger semiconductor companies - either by owning individual companies are an ETF like the SMH.

Indeed, on a personal anecdote: my own personal strategy in semiconductors was to invest primarily in two equities: Broadcom ( AVGO ) - which I consider to be one of the best-run companies on the planet, the King of high-speed networking, and one of the best dividend growth stocks in the entire S&P500 (current annual dividend of $18.40/share for a 3.0% yield), and the SMH ETF, primarily for its #1 holding and top semiconductor company Taiwan Semi ( TSM ). For years I have occasionally added to both equities on weakness. However, after watching the XSD ETF over the past couple of years, I have decided to stop adding to my existing SMH position, and on the next pull-back initiate a position in the XSD ETF and to start (slowing) adding to it over time.

XSD is a BUY. The 0.35% expense fee, while a bit higher than I would like, is worth it considering the out-sized total returns this fund has consistently delivered for its investors.

I'll end with a three-year total returns comparison of the XSD ETF against the broad market averages and the SMH ETF:

As you can see, and even despite the 2022 bear market mauling of the semiconductor sector, the XSD has beat the pants off the board market as well as the SMH Semiconductor ETF.

For further details see: