Dina Ting, CFA
Head of Global Index Portfolio Management
Franklin Templeton Exchange-Traded Funds
The United States has recently been promoting domestic semiconductor manufacturing. Can you outline for us what’s prompted this renewed activity and the importance of it?
President Biden is making the rounds now to support his administration’s two major economic policies—the CHIPS and Science Act and the Inflation Reduction Act (IRA). He’s recently been touring semiconductor chip plants in the United States, including one in the state of Michigan and TSMC’s new plant in Arizona. Both policies were signed into law this summer, with the first aiming to strengthen US domestic semiconductor manufacturing, which, as of last year, held just a 12% share of global capacity—a significant drop from about 37% in 1990.
In terms of importance, the inflation reduction initiative offers broad incentives to encourage investment in clean and renewable energy industries. And semiconductors are the world’s most widely traded product after automotives and oil.
Globally, there are fewer than about 20 producers that can make chips at scale, with East Asia and China still domi- nating the vast majority of related manufacturing and production assembly. Chip manufacturing poses immense barriers to entry with enormous capital requirements and technical complexities, so that’s kept control of the industry to a few major players in Taiwan, China and South Korea. As such, many investors appreciate having the ability to access the industry through targeted single-country allocations with heavy tech-sector weighting. That way they can tap exposure to the world’s top global chip makers, while also gaining the low-cost diversification benefits of exchange-traded funds.
With the rapid global transition away from fossil fuels and toward renewables, EV battery demand has soared. Global consulting firm McKinsey forecasts the market for battery cells to grow, on average, by more than 20% per year until 2030.11 This bodes well for South Korea’s petrochemical heavyweights, one of which is investing heavily to accelerate the sustainable expansion of its battery material production lines, including recent plans to construct a manufacturing facility for EV components in the southern United States. In terms of semiconductors, the industry’s aggregate annual growth could average 6%–8% a year, and result in a US$1 trillion-dollar industry by the end of the decade.
Investors pursuing access to the world’s top global semicon-ductor holdings may want to consider the cost-effectiveness and diversification benefits of country-focused ETFs (see Exhibit 2). Such funds can be important tools for capturing exposure to indexes heavily weighted to the information technology sector, which includes the semicon- ductor industry.
We see a bit of optimism that the bottom of the chips cycle may be near, following almost unprecedented shortages since the onset of the pandemic. This past year has seen the chip squeeze turn into a glut. Over the summer, stockpiles soared and consequently some leading firms have cut
planned capital expenditures by as much as 50% for next year. At the same time, we’re fairly confident that capacity reductions today can turn into the price hikes of tomorrow— which has often been the case with such a cyclical industry. We believe that if the semiconductor inventory cycle peaks around the turn of the year, then generally speaking, the technology sector may have already reached its lows.
Besides their substantial tech-sector weights, which offer exposure to the chip industry, the FTSE South Korea and Taiwan benchmark equity indexes are up 15% and 24%, respectively for the quarter-to-date period ending November 30. Broad emerging markets rose 11% over the same period. So they’ve widely outperformed most of their peers quarter-to-date and we think attractive valuations, strong fundamentals and the positive outlook for the chips and materials industries are all critical to keep in mind. Even considering the current demand slump, we think these markets are worthy of a closer look now. Long-term supply chain realignments could benefit both economies. Investors have also been bargain hunting amid the general equity market downturn in 2022. TSMC in particular has
come into focus recently since the United States placed new restrictions on sales of advance semiconductors to China. The increasingly popular “China plus one” strategy could allow South Korea and Taiwan to pick up some business over the medium term.
Both markets are export-oriented nations, which tend to benefit from weaker currencies. While US dollar strength has eased, both the South Korean won and Taiwan dollar are still significantly cheaper compared to levels seen at the start of the year.
Both markets also hold appealing allocations to materials and industrials holdings—with weightings currently ranging between 14% and 23%. They’re home to leading, highly profitable companies with wide moats, and have built a robust ecosystem around them. Taiwanese companies, for example, command some 11% of the world’s liner fleet. This is a crucial advantage in times of disrupted supply chains, especially for export-heavy economies, and also given that the majority of global trade is carried by sea.
South Korea additionally boasts impressive government blockchain initiatives, including plans for blockchain-powered networks to improve transparent food supply chains as well as another potential game-changer—new blockchain- based digital IDs to be implanted in smartphones and replace existing credentials. These IDs could potentially trans- form business and government efficiencies and vastly benefit South Korea’s digital economic foundation and metaverse buildout
