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The technology sector has been broadly mixed so far this year due to uncertainty surrounding some of its top players, weak overseas demand and overall reduction in global information technology spending. However, one sub-sector – Cloud Computing – has managed to prosper.

Cloud Computing is a rather under-tapped and flourishing part of the technology space. This specialized segment of the sector has been gaining momentum in recent years and represents one of the few growth opportunities left for developed market investors.

What is Cloud Computing?

Cloud computing is a process by which data or software is stored outside of a computer, but can be easily accessed from anywhere at any time via the Internet. This revolutionary idea can lower IT costs of companies by cutting down the need for servers and staff. Per one research agency, Gartner, by 2015, 10% of overall IT security enterprise product capabilities will be delivered in the cloud.

The huge growth potential of this niche segment prompted companies such as Oracle (ORCL) and SAP (SAP), which were initially hesitant to enter this domain, to go for acquisitions in cloud computing. Competition is heating up in the space among other big tech players like IBM (IBM), Hewlett Packard (HPQ) and Dell (DELL), some of which are shifting their focus from low-margin PC-centric business to the high-margin server, storage and cloud computing space.

As a point of reference, IBM is seeing strong demand for its cloud-based solutions. The company’s cloud revenues increased 80.0% in 2012. Buoyed by this robust demand, IBM expects to earn $7 billion in revenues from cloud-based services by 2015’s end (see: Inside the Cloud Computing ETF).

Industry statistics also bear out the relatively bullish trend. Gartner expects the public cloud services market to grow 18.5% year-over-year in 2013 to reach a total of $131 billion globally. It also forecasts that from 2013 through 2016, as much as $677 billion will be spent on cloud services worldwide.

How to Play: SKYY

In such a scenario, First Trust ISE Cloud Computing Index Fund (SKYY - ETF report) – the only pure-play available in the cloud space -- has seen a solid level of interest from investors, attracting over $100 million within two years of its inception. Also, since its debut, the fund has returned around 39.0% to investors.

While some broad-based technology-focused ETFs like the Select Sector SPDR Technology ETF (XLK), Vanguard Information Technology ETF (VGT - ETF report) and the iShares Dow Jones US Technology ETF (IYW - ETF report) delivered 9%, 12.9% and 7.8% respectively, the niche player SKYY delivered more than 25.0% in return in the last one year time frame.

In total, the fund holds about 40 securities in its basket. Of these firms, Facebook (FB - Analyst Report) takes the first spot, making up roughly 4.73% of the assets. Stellar earnings and subsequent surge in the share price of Facebook, Red Hat (RHT - Snapshot Report) and F5 Networks (FFIV) made possible the torrid run in SKYY. Notably, FB shares soared nearly 50% last month.

Another stock in the portfolio, Netflix (NFLX - Analyst Report) is pushing SKYY higher by attracting new subscribers and boosting earnings in the process. Some positive trends are also beginning to appear in yet another constituent – VMware – thus benefiting the fund greatly.

In terms of industrial exposure, the fund is widely spread across Software (39.0%), Internet Software & Services (22.0%), Communications Equipment (14.2%) and Computers & Peripherals (11.2%) that make up double-digit allocations.

Bottom Line

SKYY has a promising exposure profile. Given the solid results by many companies in this space and the inherent potential of the Cloud Computing segment, we could see additional gains in the months ahead (read: Robotics ETF on the Horizon?).

So, for risk-tolerant investors seeking a new play on the tech space, this somewhat unnoticed Could Computing ETF could be an interesting, albeit volatile, choice to target this surging sector.

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