Exchange traded funds (ETFs) make it harder to justify individual stock picking for retail investors, especially in the technology sector. There's no better example of what can happen to overzealous investors than looking at the epic fall of Apple (Nasdaq:AAPL). Remember when that stock was $700? Now it's well under $500, and that damage has happened over a few months rather than years.
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Compare that to the most widely traded technology ETF, the PowerShares QQQ (Nasdaq:QQQ), which is down only fractionally over the same period. There are many benefits of ETF investing, and for investors who believe in a certain sector of the economy, ETFs provide exposure to a basket of stocks in the sector of their choice.
The PowerShares QQQ may provide broad exposure to the technology sector, but as investors know, that sector is huge. One subsector of the technology space that has caught investors' eyes is semiconductors.
Recent uptrends in stocks like QUALCOMM (Nasdaq:QCOM) and Texas Instruments (Nasdaq:TXN), a name that has seen nearly 20% upside since October, are proving these stocks to be compelling buys for the first half of 2013. To mitigate the risk that comes from such a volatile sector, three ETFs might be appropriate.
The Market Vectors Semiconductor ETF (ARCA:SMH) is up a mere 2% in the past 52 weeks, but that follows an impressive recovery from its November lows. With an expense ratio of 0.35% - below the category average of 0.52% - the fund is an efficient way to play the space.
There is reason for caution, however. Nearly 35% of the fund's holdings are concentrated in two companies: Intel (Nasdaq:INTC) and Taiwan Semiconductor (NYSE:TSM). For this reason, investors have to believe strongly that Intel will not fall victim to the dwindling popularity of the PC, and Taiwan Semiconductor won't suffer the same type of mean reversion that Apple did.
Another ETF worth researching is the iShares PHLX SOX Semiconductor Sector Index Fund (Nasdaq:SOXX). This fund is better diversified than SMH, with no one current holding representing more than 8.5% of the total weight of the fund. It still invests in many of the major semiconductor companies including Texas Instruments, Intel, Taiwan Semiconductor and Broadcom (Nasdaq:BRCM).
The fund's expense ratio is 0.48%, higher than SMH, but still lower than the industry average.
The SPDR S&P Semiconductor ETF (ARCA:XSD) is the most diversified fund of the three. With an expense ratio of 0.35%, it's on par with SMH. Within the fund's 50 holdings, none of the top 10 makes up more than 3% of the fund's weight. In addition, they aren't the same names that show up in the previous two ETFs.
Names like Cree (Nasdaq:CREE), Advanced Micro Devices (NYSE:AMD), On Semiconductor (Nasdaq:ONNN) and Micron Technology (Nasdaq:MU) are in the fund's top 10 holdings.
Which Is Best?
Like all ETFs, even those that track the same sector or subsector of the economy can have very different results. Over the past 52 weeks, The Market Vectors Semiconductor ETF has performed the strongest with returns of about 2.3%. SOXX was a close second with returns of 1.8%, and XSD was a distant third, with a return of minus 4.3%.
It's clear that the funds that tracked the larger, better-known names performed better over the past year.
The Bottom Line
Investing in the technology sector is known to be very volatile. When investors think of the semiconductor space, they often think of computers, but the companies that make up these ETFs manufacture a lot more than just computer chips. This is a resilient business, but not without volatility.
At the time of writing, Tim Parker did not own any shares in any company mentioned in this article.