A Cloud Computing ETF?
June 30, 2011
What is cloud computing, and does it have a place alongside tech you might already own?
The question matters to investors, because as Olly wrote this week, First Trust's new cloud computing ETF (NasdaqGM: SKYY), is set to launch on July 6.
It's an interesting idea. According to First Trust, "spending on public cloud computing services will grow five times faster" than other spending on global information technology.
You may have already seen Oracle CEO Larry Ellison's rant against cloud computing. He doesn't see a difference between "cloud computing" and what older Internet firms have been doing for the past decade—namely building out networks and computing capacity that users can employ for just about any purpose from locations all around the world. The term "cloud computing" may be new, but little else about cloud computing is, in Ellison's view.
For investors, the most important question is whether SKYY can add something to their portfolios. And, is it worth paying 60 basis points to get that extra something?
It might be. Despite Larry Ellison's insistence that cloud computing is neither new nor interesting, SKYY's holdings are quite different from those of the Technology Select SPDR Fund (NYSEArca: XLK) and even the First Trust Dow Jones Internet Index Fund (NasdaqGM: FDN). Of the 40 companies in SKYY's benchmark, the ISE Cloud Computing Index (CPQ), only 17 are in XLK. Only nine companies are in both SKYY and FDN.
Despite the different holdings, SKYY, XLK and FDN are broadly similar in performance. To analyze returns, I used SKYY's underlying index, CPQ, since SKYY has not launched yet. CPQ has only been around since May 26, 2011, so returns are limited to the past month.
One thing that First Trust doesn't mention in its marketing materials is that SKYY has a significantly higher beta than other technology ETFs, indicating higher systematic, or market, risk.
CPQ's higher beta isn't that surprising—many of the companies that it includes are tech firms that were too small to make it into XLK or FDN. CPQ also uses a modified equal-weighting methodology that serves to further overweight small-cap companies. CPQ evenly distributes 75 percent of assets to pure-play "cloud computing" companies, which are generally newer and smaller. Indeed, four of CPQ's top five holdings have market caps below $5 billion.
In comparison, XLK's top five holdings each have market caps over $185 billion. FDN's market cap tilts more toward smaller companies, but its top five holdings still range from about $20 billion to $160 billion.
|Market Caps Of Top Five Holdings|
|Ticker||Market Cap ($,B)||Ticker||Market Cap ($,B)||Ticker||Market Cap ($,B)|
So let's get back to Larry Ellison's point. SKYY may be worth it, but not for the reasons you might think.
Pretty much every technology company is exposed to cloud computing in some way. Five of the top six components of XLK—representing nearly 40 percent of its assets—are in CPQ. First Trust recognizes this fact—it expressly includes the large technology conglomerates based on the fact that they "indirectly utilize or support the use of cloud computing."
Invest in SKYY if you're interested in exposure to mid- and small-cap tech stocks and are willing to take on the extra risk these stocks entail.
If not, XLK is a safer and—with an expense ratio of 0.20 percent—cheaper bet.