The fact that many investors underperform the S&P 500 is often a poorly understood part of investing. Although stocks like Nvidia and Tesla have experienced massive market-beating returns, numerous others underperform the index, and some lose value. Thus, investors who can meet that index benchmark are doing well.
However, some exchange-traded funds (ETFs) have beaten the S&P. Moreover, they do not have to buy stocks on a long-shot hope to find the next Nvidia. One of these ETFs focuses on semiconductor stocks, and considering its investment mix, investors have a tremendous incentive to outsource the heavy lifting of investing to these funds' managers.
What is this fund?
This market-beating fund is the VanEck Semiconductor ETF (SMH 1.51%). It contains 26 companies that together cover all aspects of semiconductor design and manufacturing.
VanEck established this fund in December 2011, and its history over more than 12 years is long enough that its track record includes a few of the cyclical downturns that have always plagued the industry, reinforcing the fund's strength.
Furthermore, the industry has changed since 2011, with the growing importance of smartphones and the emergence of chip-enabled technologies such as artificial intelligence (AI). Through that technological change, the ETF has typically outperformed the S&P 500 by a significant margin.
Of course, S&P 500 funds involve less risk since they invest in the 503 holdings across numerous industries mirroring the S&P itself. Nonetheless, taking a chance has paid off in the case of the VanEck Semiconductor ETF. Over the last year, its total returns are nearly triple that of the index, which reflects a recent sell-off in chip stocks. If you extend the timeline back 10 years, the VanEck ETF outperforms by an even wider margin.
SMH total return level, data by YCharts.
Why the VanEck Semiconductor ETF outperforms
The secret to the ETF's success (besides active, disciplined management) is likely its comparatively aggressive investments in a small number of companies that boost user productivity.
Not surprisingly, its largest position is Nvidia, making up just over 20% of the fund. Nvidia dominates the market for AI-enabled chips, enabling it to deliver triple-digit revenue growth in recent quarters, a benefit that trickles down to VanEck's shareholders.
The second-largest position is with Nvidia's primary manufacturer, Taiwan Semiconductor Manufacturing. TSMC makes the world's most advanced chips for its clients. Its third-party manufacturing market share, which is 61%, according to TrendForce, gives it tremendous influence within the industry.
The third-largest holding in the ETF is Broadcom, at 8%. Broadcom and other companies held by the ETF, including Qualcomm, AMD, and Intel, are also major TSMC clients.
Moreover, VanEck's investing discipline arguably makes the fund worth its cost. Its annual ETF expense ratio is 0.35%, well above those of S&P 500 ETFs like the SPDR S&P 500 ETF Trust and Vanguard S&P 500 ETF Trust. These funds charge expense ratios of 0.09% and 0.03%, respectively.
Nonetheless, VanEck's cost closely approximates the 0.37% average expense ratio determined by Morningstar in 2022. Given its considerably higher returns, this expense should probably not deter prospective shareholders.
Consider the VanEck Semiconductor ETF
Ultimately, the VanEck Semiconductor ETF offers market-beating returns without outlandish costs or excessive risks. Admittedly, a fund of 26 stocks in one industry is more risky than a generalized fund with hundreds of stocks, like an S&P 500 ETF.
However, the chip industry has built a long-term track record of high returns, and the fund's 26 stocks significantly reduce the risks involving large stakes in individual companies. Thus, the VanEck Semiconductor ETF is one investment where adding a little bit of risk could continue to bring considerably higher returns.
