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Why Cloud ETFs Could Soar Ahead

Sanghamitra Saha
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Technology ETFs are on a tear this year as evident by 23.6% year-to-date returns in Technology Select Sector SPDR XLK. The cyclical nature of the sector, strong demand for products in emerging technology applications like tablets and smartphones, wearables, VR headsets and drones, hopes of tax reform and solid earnings led to the stellar journey in tech stocks (read: 4 Favorite Sectors of Q3 Earnings and Their ETFs & Stocks).

Among the various corners of this broad sector, some specific areas seem to carry more potential. One such area is cloud computing. This is a budding part of the technology space and has been gaining momentum in recent years.

As per a source, spending on cloud computing services is rising faster than earlier anticipated, with software-as-a-service (SaaS) and infrastructure-as-a-service (IaaS) deserving special mention. Capital is being deployed in sectors including government, health care, manufacturing, and retail.

According to Gartner, global public cloud services market revenues are expected to increase 18.5% in 2017 to $260.2 billion from $219.6 billion in 2016. The market is projected to reach to $411.4 billion by 2020.

Gartner noted that SaaS is “growing faster in 2017 than previously forecast, leading to a significant uplift in the entire public cloud revenue forecast” and “the highest revenue growth will come from cloud system infrastructure services (infrastructure as a service [IaaS]), which is projected to grow 36.6 percent in 2017 to reach $34.7 billion.”

As per a note from RBC Capital’s Amit Daryanani, who keeps track of a cluster of cloud companies, showed that “spending on cloud computing by the cloud titans -- Apple, Google, Microsoft et al. -- is showing improving trends.” His model and data from FactSet indicated that there was 17% growth in cloud capital spending in 2016. The overall spending should increase 15% this year and again 17% growth in 2018.

Below we highlight a few ETFs that are going to benefit from a rising cloud capex.

First Trust ISE Cloud Computing Index Fund SKYY

This fund provides exposure to cloud computing securities by tracking the ISE Cloud Computing Index. Holding about 30 stocks, it is pretty well spread out across components with none holding more than 5.0% of assets. Software firms dominate this ETF, accounting for about 40% share. Internet Software & Services and Communications Equipment hold two next spots. It has 0.60% in expense ratio (read: Tech ETFs to Watch Post Oracle Earnings).

VanEck Vectors Semiconductor ETF SMH

Nvidia NVDA, Intel INTC, Broadcom AVGO – semiconductor behemoths – are likely to gain from the uptick in cloud capex. According to RBC Capital, HDDs and semis have considerable exposure to cloud capex.

The report indicates that for Intel, cloud and hyperscale spending is a rapidly expanding area of Intel’s NAND and Data Center Group business and may make up about one-third of DCG revenues ($6 billion of about $17 billion in 2016 DCG revenues). “Nvidia has exposure through their Tesla and Quadro businesses. Broadcom has exposure to the cloud through their Enterprise Storage segment (HDD controllers) and general data center buildouts in their Wired Infrastructure segment”, as per the report.

Since Intel takes about 9%, Nvidia holds about 5.5% and Broadcom about 4.5% of the fund SMH, the fund could be a great beneficiary of the uptick in cloud business.

iShares U.S. Technology ETF IYW

RBC Capital reports that Apple AAPL is the “single largest spender on cloud”, accounting for about 24% of the total outlays in 2016. Alphabet Inc. GOOGL comes next at 19% followed by Microsoft MSFT at 17%.

This puts IYW on the strong buy list. Apple Inc (16.7%), Microsoft Corp (12.3%), Alphabet Inc Class A (6.19%) and Alphabet Inc Class C (6.15%) occupy about 40% of the fund. Intel, Nvidia Oracle and IBM get places in the top 10 holdings of the fund (read: Invest in FANG Stocks With These ETFs).

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