ETFs for a Chip Rally

Here are some domestic and overseas ETF plays for the coming rally in the semiconductor sector.
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NEW YORK (TheStreet) -- Although rising demand for semiconductors has the sector climbing higher on renewed optimism, ETFs with a focus on the industry have performed poorly year to date. Here's how to play a reversal in that performance in the coming weeks.

One of the driving forces for chip demand this year is the upgrade cycle. Many firms have delayed new technology investments. On top of the global recession, there was the negative opinion of the Windows Vista operating system. But Windows 7 has replaced Vista and the economy is picking up, leading firms to consider hardware and software upgrades for the first time in years.

Two of the big players and well known names in the semiconductor sector are

Texas Instruments

(TXN) - Get Report

and

Intel

(INTC) - Get Report

, and they're prominent in the semiconductor ETFs as well.

TXN and INTC are both included in what I see as the two most balanced semiconductor focused funds,

iShares S&P North American Technology-Semiconductors Index Fund

(IGW)

and

SPDR S&P Semiconductor Index

(XSD) - Get Report

.

INTC accounts for 8.4% of IGW and 4.2% of XSD while TXN accounts for 7.5% of IGW and 4.4% of XSD.

In terms of company allocations, XSD is the more balanced fund, since the majority of its 27 holdings account for between 3.6% and 4.6% of net assets.

That doesn't mean IGW is unbalanced. The fund only allocates 8.4% to its largest holding, INTC, and with 52 total holdings, it offers exposure to nearly twice as many companies as XSD.

Both funds are finely balanced in comparison to another popularly traded fund with a focus on the sector,

Semiconductors HOLDRs

(SMH) - Get Report

. For instance, INTC and TXN account for 23% and 19.8% of SMH, respectively.

In addition to being more balanced than SMH, IGW and XSD also do not place a minimum on the number of shares an investor must buy, whereas with SMH, the minimum is 100 shares.

Despite positive sentiment in the industry, year to date IGW and XSD are down by 1.6% and 2.1%, respectively, in comparison to a flat return for the

S&P 500

.

SMH managed to outperform IGW and XSD, but it is still slightly underperforming the S&P 500 with a decline of 1.3% so far in 2010.

Another way to play a rebound in the semiconductor sector is to gain exposure via international ETFs with large sector exposure. There are two country-specific ETFs that spring to mind.

The first is

iShares MSCI Korea Index Fund

(EWY) - Get Report

. The fund's top holding is Samsung, which accounts for a hefty 18.1% of holdings.

In its last earnings report, Samsung noted that its chip business was a significant source of revenue growth for the company. More recently, the company announced that it would be investing $3.6 billion in a chip production plant in Austin, Texas, in a bullish gesture that future chip demand will stay strong.

Another international play on semiconductors is

iShares MSCI Taiwan Index Fund

(EWT) - Get Report

.

This fund's top holding, accounting for 13.8% of assets, is

Taiwan Semiconductor Manufacturing

(TSM) - Get Report

.

In addition to TSM, the fund has several other tech-related companies outside of the specific semiconductor sector and information technology accounts for 60.8% of the assets in this ETF.

In sum, the best way to play a rally in the semiconductor sector, with a domestic slant, is by using XSD or IGW. For an international play on the rally, EWT or EWY are the best choices.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion Money Management was not long any equities mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.