An ETF With Sky-High Potential

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The technology sector is littered with emerging themes and corresponding exchange traded funds (ETFs) that offer tactical investors compelling long-term potential. A prime example of a booming theme buoyed by favorable fundamentals is cloud computing, which is accessible in basket form via the First Trust Cloud Computing ETF (SKYY).

The $2.09 billion SKYY turns eight years old in July and tracks the cap-weighted ISE Cloud Computing Index. While cloud computing has been receiving increased attention in recent years, it is still a relatively new industry group within the broader technology sector. Said another way, cloud computing as an industry is not as old as, say, semiconductors or traditional software.

As such, there are some qualifiers that are part of SKYY's underlying index. For instance, the index allows for the inclusion of three types of companies: dedicated cloud providers, non-pure play cloud companies and technology conglomerates.

An example of a dedicated cloud company would be VMware (VMW), SKYY's second-largest holding; while an example of a non-dedicated company with some cloud exposure would be Facebook (FB), SKYY's sixth-largest holding. A technology conglomerate would be a company such as IBM (IBM), which is also a SKYY constituent.

SKYY conglomerate exposure is defined as follows: “technology Conglomerate Cloud Computing Companies: Large broad-based companies that indirectly utilize or support the use of cloud computing technology.” The fund's index caps exposure to those companies at 10%.

The Cloud = Growth

Going beyond the mechanics of SKYY, the growth trajectory of the cloud business is what sets the table for this ETF.

“The worldwide public cloud services market is projected to grow 17.3 percent in 2019 to total $206.2 billion, up from $175.8 billion in 2018,” according to Gartner, Inc.

Cloud application software, also known as software as a service or SaaS, underpins the growth of cloud computing, but other corners of the market are emerging as credible revenue drivers.

“The fastest-growing segment of the market is cloud system infrastructure services (infrastructure as a service or IaaS), which is forecast to grow 27.6 percent in 2019 to reach $39.5 billion, up from $31 billion in 2018,” said Gartner.

Courtesy: Gartner, Inc.

Cloud-related investment opportunities are spread across multiple corners of the communication services and technology sectors. SKYY reflects as much as the cloud ETF features exposure to 27 stocks from eight industry groups. Underscoring the point that the cloud is big business for big technology companies, the median market capitalization of SKYY's holdings is $49.13 billion.

A prime example of a mega-cap technology company with significant cloud exposure is Microsoft (MSFT), which is a 2.41% weight in SKYY.

"We estimate Azure (Microsoft’s cloud business) is approximately a $7 billion business and it still grew by a staggering 76% year over year in the December quarter,” said Morningstarin a recent note. “The battle for cloud supremacy has become a two-horse race between Azure and AWS (Amazon Web Services), and Azure is well-positioned given its installed base at enterprise customers with Server, Database, Dynamics, and Office. Enterprise clients are increasingly adopting a hybrid cloud environment, which plays into Microsoft’s strong position, as the company can offer customers their existing environment in either public cloud or on premise flavors.”

Bottom Line

Past performance is never a guarantee of future returns, but over the past three years, SKYY has easily outperformed broader, traditional technology indexes and ETFs with less annualized volatility.

Bolstering the long-term case for cloud stocks and SKYY is cloud computing's intersection with an array of disruptive, emerging technologies, such artificial intelligence, cybersecurity and healthcare innovation.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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