The Case for Fabless Semiconductor Diversification: Opportunities Beyond Nvidia

Nvidia has become a cornerstone in the semiconductor industry, especially for investors who have enjoyed its remarkable growth and exceptional margins. However, there is increasing speculation that these margins could eventually be pressured as competition intensifies. As this potential scenario becomes more apparent, investors should consider diversifying their exposure to the broader fabless semiconductor market. This strategy could offer a balanced approach, allowing investors to benefit from the growth of other fabless companies that might challenge Nvidia’s market position.

A Growing Case for Diversification

Nvidia’s AI and graphics processing success has been extraordinary, yet the semiconductor landscape is rapidly evolving. Competitors such as AMD, Qualcomm, and other emerging players are continually innovating and could potentially gain market share at Nvidia’s expense. Given the uncertainties surrounding Nvidia’s future dominance, diversifying exposure within the fabless semiconductor space could help manage risks while capturing potential opportunities across the sector.

Investing in a Fabless Semiconductor ETF provides a way to gain exposure to a wide range of companies operating under the fabless model. This approach could allow investors to participate in the broader industry trends that have driven Nvidia’s success while spreading risk across multiple companies that are well-positioned to benefit from ongoing innovations in the semiconductor industry.

Fabless Chip Designer Revenue Globally 2017-2023 (By Quarter)

Source: Statistica as of December 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

AMD’s Acquisition of ZT Systems: Reinforcing the Fabless Trend

AMD’s recent $4.9 billion acquisition of ZT Systems marks a strategic expansion into the data center market, particularly in server and cloud solutions. A critical aspect of this acquisition is AMD’s intention to spin off ZT Systems' manufacturing operations, aligning with the fabless model that AMD has championed. This move allows AMD to maintain its focus on chip design and innovation while outsourcing the capital-intensive and complex manufacturing process.

This approach is not new for AMD. Over a decade ago, AMD spun off its manufacturing operations, leading to the creation of GlobalFoundries. By transitioning to a fabless model, AMD could streamline its operations, reduce costs, and concentrate on what it does best—developing high-performance semiconductors. The ZT Systems acquisition, paired with the planned manufacturing spin-off, reflects AMD's continued commitment to the fabless strategy, which has proven successful.

This strategic focus on design and innovation, while leveraging specialized foundries for production, positions AMD to better compete with Nvidia and other industry giants. It also underscores the broader industry trend toward the fabless model, where companies can achieve greater agility and efficiency by outsourcing production to dedicated foundries like TSMC.

Apple’s Role in the Fabless Movement

Apple’s evolution into a key player in the semiconductor space underscores the appeal of the fabless model. Apple has effectively embraced a fabless strategy by designing its own chips, such as the M1 and A-series processors, and outsourcing their manufacturing to TSMC. This approach has enabled Apple to produce highly efficient, performance-optimized chips tailored to its devices without the burden of owning and operating semiconductor fabrication plants.

Apple’s success with this model suggests that other technology companies might explore similar strategies, further validating the fabless approach. The ability to innovate and control chip design while leveraging the expertise of specialized foundries for production is becoming an increasingly attractive business model in the tech industry.

Considering the Fabless Future

The semiconductor industry is in a state of flux, with the fabless model gaining traction as a preferred strategy for many leading companies. As Nvidia’s margins face potential pressures from growing competition, diversifying investments within the fabless sector could offer a way to navigate these uncertainties. By spreading exposure across a range of fabless companies, investors might be better positioned to benefit from industry growth while managing the risks associated with any single company's future performance.

VanEck Fabless Semiconductor ETF (SMHX) aims to provide a diversified portfolio that captures this dynamic industry's broad spectrum of opportunities. While Nvidia remains a dominant player, SMHX offers exposure to other fabless companies that could challenge Nvidia’s market share and thrive in the evolving semiconductor landscape.

As the industry continues to shift toward the fabless model, investors may want to consider broadening their semiconductor exposure. By doing so, they could potentially benefit from the ongoing innovations and competitive dynamics shaping the future of the semiconductor market while also managing the uncertainties inherent in this rapidly changing industry.

Cumulative Performance of Fabless Names Outpaces the Category and Broad Markets

Source: Morningstar, Data as of 07/31/2024. The BlueStar Top 10 U.S. Listed Fabless Semis does not represent the funds underlying indices. The performance data quoted represents past performance. Past performance is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. See important disclosures and index descriptions at end. This is not an offer to buy or sell, or recommendation to buy or sell any of the securities mentioned herein. Futures carry additional risks and are not suitable for all investors.

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