China Wants Its Own Chips. Now There's an ETF for It

VanEck, the issuer behind the $74 billion VanEck Semiconductor ETF (SMH), the largest semiconductor ETF on the market, rolled out a China version of its hit product last week.

The VanEck China Semiconductor ETF (SMHC) tracks the MarketVector China Semiconductor 25 Index, which holds the 25 largest Chinese semiconductor companies, and carries a 0.65% expense ratio. It came out of the gate with healthy interest, trading 2.8 million shares on Monday.

The thesis behind the fund is, at first glance, compelling. China, like the U.S., is pouring money into artificial intelligence, and semiconductors sit at the center of that buildout. Earlier this month, news reports suggested that Beijing is preparing to spend roughly 2 trillion yuan, or about $295 billion, over five years on a state-directed nationwide AI infrastructure program. 

That figure does not include spending by private Chinese companies like Alibaba and Tencent, which have already been spending aggressively on AI much like their U.S. counterparts.

The Problem Isn't Money

That said, money is only one ingredient, and China has plenty of it. What it lacks is access. Because of the geopolitical rivalry between the two countries, a wall of U.S. export restrictions has cut China off from the best technology. 

The most advanced Nvidia chips cannot be sold into the country, and even the previous-generation of hopper chips, which Washington recently cleared for sale, is not actually shipping in any volume. 

Part of that is Beijing's own doing, as the government increasingly steers domestic buyers toward homegrown silicon rather than stay dependent on the U.S. for technology it views as strategically critical. China also cannot tap leading-edge chips from TSMC or the most advanced lithography from ASML.

So China is attempting to build an entirely separate, homegrown semiconductor supply chain. That is the bet SMHC is offering exposure to.

Reasons for Caution

That said, a few things are worth keeping in mind.

For one, the fund excludes sanctioned companies, which makes sense for a U.S.-listed product. But it also means some of the most important names in Chinese chips are missing. The most prominent example is SMIC—the country's largest foundry and its answer to TSMC—which sits on a U.S. investment blacklist and therefore cannot be held.

Second, Chinese stocks broadly have been shunned by U.S. investors in recent years. Even when fundamentals and growth tailwinds look strong, as they have at various points for the original China tech darlings like Alibaba, Tencent and Baidu, multiples stay compressed because investors price in the geopolitical risk of owning shares in companies based in America's chief rival.

Third, China's system works differently. It has capitalist elements, but the state holds far more sway over private companies than in the U.S. That means national priorities can override shareholder interests, capital does not always flow to its highest-returning use, and the kind of regulatory crackdown that hammered Chinese tech in 2021 is always a risk.

All in all, SMHC is an interesting product. It may carve out a niche following much the same way the KraneShares CSI China Internet ETF (KWEB) eventually grew into a multibillion-dollar fund, giving U.S. investors a vehicle for a corner of the China story they otherwise could not easily reach.