- SOXL seeks to provide 3x the daily investment return of the Philadelphia Semiconductor Sector Index.
- The fund is a good choice for investors with a short-term investment horizon.
- On the other hand, this fund may underperform if it is held for the long-term.
- Given near-term uncertainties caused by COVID-19 and Huawei ban and the surge of its fund price due to market optimism, the risk and reward profile is not attractive.
Direxion Daily Semiconductor 3x Bull Shares ETF (NYSEARCA:SOXL) aims to seek 3x the daily investment return of the Philadelphia Semiconductor Sector Index ("PHLX"). The fund has very high risk as it uses leverage achieve 3x of the daily returns of the index. Although it may offer substantial returns, it can also result in substantial losses if the index declines. The fund is not a good long-term investment choice and is only suitable for investors with a short-term investment horizon. Given the fact that the semiconductor industry is facing some near-term uncertainties, we think it may be better for investors to stay on the sidelines.
SOXL is a leveraged-ETF
Unlike other ETFs that only include stocks and some cash in their portfolios, SOXL uses financial derivatives and debt to amplify the daily performance of PHLX. In fact, as the title of SOXL suggests, it seeks to leverage the performance by 3x the result of the daily return. Therefore, investors may be able to magnify its return by 3x in a particular day. On the other hand, SOXL’s fund value can shrink quickly if PHLX declines in value. Therefore, leveraged ETF is a double-edged sword and the risk is very high. Therefore, SOXL is only suitable for investors with experience and willing to take on high risks.
This ETF is not a long-term play
Like any other leveraged ETFs, SOXL is not suitable to own in the long-term. There are several reasons. First, it has a much higher expense ratio of 0.96% than regular ETF that tracks the PHLX. Other ETFs such as iShares PHLX SOX Semiconductor Sector Index ETF (SOXX) has a much lower ratio of 0.46%. Second, SOXL rebalances daily. Since leverage needs to be reset on a daily basis, there is a high likelihood that SOXL will underperform the PHLX index. Let us use a simple example and assume that SOXX and SOXL's price starts at $100 per unit. In an ideal world where there is no expenses, if SOXX declined by 5% in one day, SOXL's fund value will decline by 15%. Hence, SOXX's price will decline to $95 and SOXL will decline to $85. The next day, if SOXX gained 5%, its price will return to $99.75. Hence, the loss will be 0.25% over two days. Many investors might think that SOXL's value would loss by about 0.75%. However, since SOXL resets daily, its fund price will only climb to $97.75 (a 15% gain from $85). Therefore, the actual loss is magnified to 2.25% instead of 0.75%. Therefore, the fact that SOXL rebalances daily makes it only suitable for investors with a short-term investment horizon. As can be seen from the chart below, SOXL’s fund performance of 59.7% in the past 3 year is much lower than SOXX’s 75.6%.
Should you be bullish on the semiconductor industry now?
Now that we have discussed some fundamentals of SOXL, we will discuss whether this ETF is a good choice to invest in the near-term. We know that the semiconductor industry has the potential to grow its market by a growth rate of 4% annually from 2020 to 2024. However, as we have discussed earlier, SOXL is not a fund suitable for investors with a long-term investment horizon. Therefore, we need to consider if the semiconductor industry will grow in the second half of 2020. According to IDC, the semiconductor industry is expected to decline by 7.2% in 2020 (excluding DRAM and flash). Decline is expected to be broad-based across different segments due to the impact of COVID-19 (see table below). Although the U.S. job report in May appears to be very positive, much of the semiconductor industry growth also depends on emerging markets. Given the fact that many emerging markets are also experiencing challenges due to COVID-19, it is hard to be very optimistic.
Growth in 2020 (%)
Source: Created by author; IDC
In the near-term, the semiconductor industry may also be impacted by the U.S. government’s policy towards banning semiconductor exports to China’s Huawei Technologies. This may suppress semiconductor demand also. Given these near-term headwinds, it appears that SOXL is not the best place to invest right now.
As we have discussed in our article, we believe SOXL is only suitable for experienced investors that have a short-term investment horizon. Given the fact that the semiconductor industry is facing some near-term headwinds, the risk and reward profile is not attractive. Therefore, we think it may be better to wait on the sidelines.
This article was written by
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