That sound you hear is the air coming out of the chip sector. Global industry sales grew five percent in the third quarter versus the year-earlier quarter, down from a growth rate of 12 percent in the second quarter. In response, the PHLX Semiconductor Index has slid more than 15 percent since Labor Day.

And we may not have even hit bottom. Analysts at Merrill Lynch believe the current slowdown in chip demand may continue into the spring, ahead of an expected upturn in the second half of 2019.

Nick Kalivas, senior equity product strategist at Invesco, points to recent earnings reports from firms such as Texas Instruments that suggest excess industry inventories need to be worked off. And he notes the slowing economy in China is hurting demand for chips in the near-term, though a resolution of the current trade spat between the U.S. and China would help sector sentiment.

Still, the current industry downturn is likely to be much more muted than previous industry cycles. That’s because there are so many new areas of technology that are driving chip demand.

Take autos, for example. Popular hybrid vehicles contain more than $900 worth of chips, according to McKinsey & Co., or three times more than in a traditional vehicle. And advanced navigation systems, enhanced safety technology and autonomous driving will boost chip content even higher. 

The Internet of Things, big data analytics, artificial intelligence and 5G telecom networks are also expected to drive chip demand higher during the next few years.

“The next growth cycle will see a rise in demand for more powerful and efficient chips, especially with the expanded integration of augmented and virtual reality technology,” says Tom Bowles, research director at Defiance ETFs. “Looking further down the road, quantum computing and other game-changers will inject tremendous growth into the semiconductor industry.”

Current Reality

Investors may already be looking past the current trough, as witnessed by recent fund flow action in the VanEck Vectors Semiconductor ETF (SMH). The leading chip ETFs offer clear contrasts in terms of their industry approach, enabling investors to target a favored part of the sector.

For example, the Invesco Dynamic Semiconductors ETF (PSI) has greater exposure to small- and mid-sized chip makers. And that focus has often paid off when the chip industry’s biggest players pursue growth-through-acquisition strategies.

Chip maker Broadcom, for example, has acquired 57 smaller rivals during the past two decades—often at significant premiums.

A robust recent period of industry consolidation helps explain why the Invesco fund has outpaced the iShares PHLX Semiconductor ETF (SOXX) on an annualized basis by about 1.5 percentage points during the past five years.

The iShares fund can be seen as a sort of ETF sector proxy. It’s based on a modified market capitalization-weighted index, which gives it a relatively greater emphasis on the industry’s bigger players. Eighty percent of this fund is invested in large-cap companies, compared to 43 percent for the Invesco ETF.

The Invesco fund’s broader focus helps to reduce portfolio concentration. While the iShares fund has roughly 62 percent of its assets invested in its top 10 holdings, that figure drops to 48 percent for the Invesco fund.

Still, in a head-to-head comparison the Invesco fund appears to have its own set of drawbacks. The fund’s 0.61 percent expense ratio is 14 basis points higher than the iShares product. And the Invesco fund’s “dynamic” approach doesn’t appear to add a lot of value over the long haul.

Similar to other so-called dynamic ETFs at Invesco, the firm’s chip fund takes a factor-based approach to portfolio rebalancing. The underlying index selects components based on price momentum, earnings momentum, management action (share buybacks, dividend boosts, etc.) and value.

Has this semi-active approach paid off? The Invesco fund sees sharper drops during periods of sector weakness, and those pronounced dips means the Invesco fund has produced roughly 1.5 percent lower annual returns compared to the SOXX ETF over the past decade.

In short, the Invesco fund appears to be a solid choice if you think the broader “chips-in-everything” theme will drive industry growth in the next few years. But if you are a bit more cautious about industry cycle dynamics, the iShares fund offers smoother returns.

The VanEck Vectors Semiconductor ETF, which has an appealing 0.35 percent expense ratio, is clearly aimed to the industry’s leading players. The fund has nearly two-thirds of its assets in large chip makers, including double-digit weightings in Intel Corp. and Taiwan Semiconductor Manufacturing.

The latter is far and away the world’s largest provider of outsourced chip making. Demand for the firm’s foundry services reflect the demand trends at hundreds of small “fabless” chip makers.

And Taiwan Semiconductor says business conditions are looking good. It recently predicted 2019 sales would grow close to 10 percent as demand for newer chips starts to build.

As noted earlier, tech investors have expressed concern that trade wars with China would lead that nation to boost its own chip-making abilities. Such fears may be overblown.

A recent study by PricewaterhouseCoopers LLP found that U.S semiconductor companies spent $329 billion on R&D in the year ended June 30, compared to $61 billion spent in China. The chip industry is especially dependent on fresh R&D spending, as the newest chips often represent major leaps over prior generations.

The notoriously cyclical chip sector had a gloomy October, but the long-range picture looks brighter. Investors who take a long-term might view the industry’s recent downdraft as a potential buying opportunity.