2023-05-03 06:19:13 ET
Summary
- XSD could be very attractive for investors looking for sustainable high growth over the longer term with manageable downside volatility and risks.
- Semiconductors are arguably one of the best growth sub-industries for the long term fuelled by the 4IR.
- XSD seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Semiconductor Select Industry Index.
- The XSD invests in a diversified portfolio of 38 US stocks providing investors with equal weight exposure to small, medium and larger stock capitalization.
- XSD has delivered exceptionally strong total return performance since its inception, outperforming competitors over the last 3 and 5 years.
Investment Thesis
The SPDR S&P Semiconductor ETF ( XSD ) is an ideal investment for great growth that is sustainable for the long term. It ticks all of the following boxes:
- It targets a sub-industry with great growth prospects.
- It solves the diversification challenge by avoiding over exposure to a single company or few companies.
- Downside volatility is effectively managed – an important factor for many investors.
- It provided exceptional growth over multiple timeframes within the last decade.
This article will look at some of the background and trends within the semiconductor sub-industry to explain the context. Then it will veer into details about the fund, its approach, holdings, performance and risks.
Semiconductor Sub-Industry Background
Semiconductors are arguably one of the best growth sub-industries in spite of shorter-term downturns and cycles indicated by the long-term big picture. It seems obvious to me that tailwinds from the Fourth Industrial Revolution (4IR) should provide strong support for this sub-industry for decades to come. I would say that we are only in the infancy of the 4IR. I base this statement on examples in industry trends like autonomous driving and the progression with smartphone apps we are witnessing around us. I see this as the sub-industry to have sufficient exposure to for long-term capital growth. I believe what oil and car producers did for investors during the 20 th century, semiconductor companies can do for investors during the 21 st century.
Worldwide Sales & Unit Growth
The growth trend in the semiconductor sub-industry is undeniable, according to an article by Robert Casanova:
In fact, zooming out from short-term demand fluctuations and looking at the long-term trend over the last two decades, the semiconductor industry has shown consistent growth (figure 1). Annual sales grew from $139 billion in 2001 to $573.5 billion in 2022, an increase of 313 percent. Over this same period, unit sales of semiconductors increased by 290 percent, reflecting the increased demand for semiconductors throughout the economy...
What can be seen in this graph is the worldwide sales and unit shipments of semiconductor chips over the last 22 years with indicated recessions. My observation is that the bigger picture is showing a very clear growth trajectory irrespective of short term recessionary impacts or other cycles.
Consumer Sector Growth
The smartphone is an important driver of chip unit growth in my opinion. About 25-30 years ago, a mobile phone was considered a luxury item for the rich. Today it is an essential item for everyone (including the poor). Many apps essential for daily life can only be accessed through a smartphone, however its useable life is relatively short due to the multi-app and high intensity usage. The smartphone has virtually become a consumable item requiring replacement about every 2 – 4 years for most, irrespective of its technological sophistication and cost. The global market is massive with the demographic including teenagers right through to seniors.
This graph is giving a striking summary of worldwide semiconductor market revenue growth by consumer application from 2020 to 2030:
A very clear growth trajectory as classified by consumer application can be observed. Servers and data centers are big drivers as the demand for recorded data are growing at a very high rate through various technologies of the 4IR. Another growth driver is the automotive sector with its related technological advancement and self-drive developments. I can identify with and relate to most of these consumer applications in my daily life. They are all reliant on chips as the key manufacturing components.
The relation to XSD
XSD follows the S&P Semiconductor Select Industry Index. The semiconductor segment of the S&P Total Market Index (“S&P TMI”) is represented here tracking the broader U.S. equity market. It is an equally weighted index giving exposure to smaller and mid-size companies in addition to larger caps. This is providing for a more even spread of risk with lower concentration on one single stock or few stocks. A fair amount of mid and smaller cap stocks are included in the fund. This inclusion is supporting greater growth potential as supported by the fund performance analysis section later in this article. Interestingly enough, the greater exposure to mid and smaller caps does not seem to increase downside volatility, but more about this later.
Fund Objectives and Approach
As per the Fund Manager, State Street Global Advisors key features :
The SPDR® S&P® Semiconductor ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P® Semiconductor Select Industry Index (the “Index”)
Seeks to provide exposure to the semiconductors segment of the S&P TMI, which comprises the Semiconductors sub-industry
Seeks to track a modified equal weighted index which provides the potential for unconcentrated industry exposure across large, mid and small cap stocks
Allows investors to take strategic or tactical positions at a more targeted level than traditional sector based investing
The Index is reviewed on a quarterly basis and selecting stocks based on the following criteria :
(i) have a float-adjusted market capitalization greater than or equal to $500 million with a float-adjusted liquidity ratio (defined by dollar value traded over the previous 12 months divided by the float-adjusted market capitalization as of the index rebalancing reference date) greater than or equal to 90% or have a float-adjusted market capitalization greater than or equal to $400 million with a float-adjusted liquidity ratio (as defined above) greater than or equal to 150%; and (ii) are U.S. based companies...
The “dollar trade volume to float-adjusted market cap” ratio principle is employed on a quarterly basis here and seems to me to be an effective way to achieve outperformance to peers as well as the broader semiconductor market. This is supported by most of the performance figures shared in this article.
Fund Holdings
A good level of diversification is achieved within XSD with its current 38 constituents, considering the smaller number of holdings for semiconductor ETFs. For example SOXX carries 35, SMH 26, PSI 32 and FTXL 32 according to a Seeking Alpha comparison . Here is a full list of XSD holdings on April 25, 2023 with indicated weights:
An interesting observation is that the 2 mega caps (NVDA & AVGO) are occupying the number 2 & 11 spots. The top 10 (26.32% of constituents) only carries 28.21% of the total fund value with the bottom 10 carrying 17.88%. This is effectively avoiding a “top heavy” fund allocation spreading risk more evenly in my opinion.
Fund Performance Analysis
To better understand the quality and performance of the constituents, some analysis of the average of the top 10 as well as the average of the bottom 10 is looked into. The metrics used include total return performance, earnings per share growth and related measures. Although 1, 3, 5 and 10 year time horizons are included, consideration must be given that constituents might not be included in the fund from the start of these periods.
Total Return Performance
Author's analysis based on stats from seekingalpha.com
Exceptionally impressive performance figures for the top 10 average are observed (based on statistics from SA Portfolio Builder ). A substantial difference is noted between the top 10 and bottom 10 with the aggregate fund figure somewhere in between which is still impressive by any standard.
EPS Growth
Author's analysis based on stats from seekingalpha.com
The Earnings per Share Growth on Year to Year basis (based on statistics from SA Portfolio Builder ) is showing a drop of nearly 21% for the top 10 and a small increase for the bottom 10 and might be related to the current downturn & / cyclical nature of semiconductors in my opinion. The annual EPS over the last 3 years are displaying less difference between the top 10 and bottom 10 averages and are both great figures. It is encouraging for me to see the bottom 10 having very strong 3 year earnings growth underlining the general growth potential within the fund in the medium to longer term in my view.
Key observations from the fund performance analysis
The overall fund’s total return performance is impressive with the top 10 notably higher than the bottom 10. Related to this is the earnings per share annual growth which is very strong over the last 3 years, irrespective of the weak YoY figure. It is encouraging for me to see the bottom 10 having even stronger earnings growth than the top 10 constituents and underlining the general growth potential within the fund in the medium to longer term for me. My overall perception of the fund is that the composition is bringing together the best of price performance and medium to longer term EPS growth in a focused fund, while avoiding top-heavy and over-exposure risks.
Total Return Comparison
For reference, how does XSD compare to a few rivals? Here is a comparison with PSI, SOXX, SMH, FTXL and for reference QQQ (from SA Comparison Builder )(as on market close April 26 th 2023):
As can be seen, XSD leads in the key investor metric of total returns. It has superior 3-year (89.37%) and 5-year (171.72%) figures (figures are always net of fees). It is also interesting for me to note that XSD's outperformance does not come with any noticeable downside volatility. In general, the Semiconductor ETFs have even bigger outperformance relative to QQQ over the past 3 years.
Manageable Risks
XSD’s Assets Under Management is $1.43 billion –smaller than SOXX and SMH at $7.12 billion and $7.06 billion respectively, but bigger than PSI and FTXL at $509.21 million and $912.96 million respectively (based on statistics from SA Comparison Builder ). The size of the Assets Under Management could potentially be a risk, manifesting in slightly higher trading spreads with lower volumes. My view on this matter is that it is manageable for most if not all long-term retail investors following a dollar-cost-averaging approach with only small to negligible impact on overall investment returns.
XSD’s asset allocation inclusion of mid to smaller caps could potentially result in higher volatility, although this did not manifest at all over the past 5 years relative to the larger cap ETFs as per the 5 year total return graph above. The smaller cap inclusion of XSD could also drive outperformance as manifested. The equal weighting approach for stock selection is reducing risk of over exposure to a single stock or few stocks (top-heavy effect) in my view with Rambus Inc. the biggest holding at 3.45%. XSD also has the largest number of constituents compared to the peers in this article.
Semiconductors might be in a downturn currently, but this seems to be related to short term factors not impacting the medium to longer term upward trend as can be seen in the Sales and Unit Shipments graph earlier in the article. The upward trend projection is strongly supported by everyday retail consumer and industrial products driven by the 4IR in my view.
Conclusion
XSD is a top performing semiconductor ETF measured by total return. Outperformance is achieved by a “dollar trade volume to float-adjusted market cap” ratio principle and inclusion of smaller cap stocks with great earnings growth. I am not aware of better total return for any similar type of ETF over 3 and 5 years without the compromise of high downside volatility. Considering its great track record over more than 17 years, I would recommend this ETF to be carefully considered by any growth investor, especially as an alternative / complementary investment to mega-cap top heavy funds. I believe that with a dollar-cost-averaging approach, XSD offers long-term investors sustainable and very fast growth supported by long-term tailwinds from the 4IR.
Please comment or share your thoughts / growth ideas / alternative growth investment(s).
For further details see:
XSD: Growth Is Sustainable For The Long Term