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Inside The Cloud Computing ETF (SKYY)

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Technology investing has been quite rocky as of late thanks to troubling setbacks form some of the major players in the industry. Giants such as Oracle (ORCL - Free Report) , Amazon (AMZN - Free Report) , and HP (HPQ - Free Report) have all seen some level of weakness over the past month, casting a shadow over the sector heading into 2012. Yet, despite these recent concerns, the tech SPDR (XLK - Free Report) has still outperformed broad markets over the past few months and could continue to do so if some of the high growth corners of the market can carry the weight of the industry in the new year. One such segment that has great promise from both a practical and investment standpoint undoubtedly has to be the cloud computing industry, an increasingly important part of the tech world (also read Intel Report Crushes Semiconductor ETFs).

To The Cloud!

Cloud computing is a process in which data or software is stored outside of a computer, but can be easily accessed from anywhere at anytime via the internet. This idea has been truly revolutionary and may help firms lower IT costs by cutting down on the need for servers and the required staff to maintain the hardware. Instead of keeping things in house, firms can now outsource the ownership of IT infrastructure to a third party who specializes in this technology. These specialists should be able to do this more efficiently than single firms can by themselves, thereby decreasing costs for everyone. Furthermore, when companies need additional storage space, they can just request more from a provider instead of having to install more servers and let some capacity sit idle. This increases scalability and helps keep costs in line with actual usage, allowing managers to know the true costs of their storage systems at all times (read Direxion Launches Insider Sentiment ETFs).

Beyond these cost issues, there are practical benefits as well. Since everything is on the internet, users can simultaneously use a document and can access it at all times of the day, no matter where they are in the world (think Google Docs). Issues of lost files can also be mitigated and backups of files could rapidly become a thing of the past thanks to the advent of cloud computing.

Due to these advantages, cloud computing has taken off in years past and looks to continue to surge higher in the future. In fact, cloud revenues are up 27% annual and are expected to approach nearly $160 billion by the end of the decade, creating a massive investment opportunity in the process. Thanks to this exciting future, First Trust, the issuer behind a number of novel ETFs, has recently put out a fund targeting the space, the ISE Cloud Computing Index Fund (SKYY - Free Report) .

Cloud Computing ETF

SKYY tracks the ISE Cloud Computing Index which follows a diversified benchmark of firms that are engaged in the cloud computing industry. Currently, 41 companies are in the index and the fund charges investors 60 basis points a year for its services. To be included in the index, a security must be engaged in a business activity supporting or utilizing the cloud computing space, listed on an index-eligible global stock exchange and have a market capitalization of at least $100 million (for another take on the market, check out Three Low Beta Sector ETFs).

Beyond these stipulations, the fund also breaks down the securities into one of three groups; pure play cloud computing firms, non pure play cloud computing companies (firms that have a focus outside the cloud computing space but provide goods and services in support of the cloud computing space) and lastly, technology conglomerate cloud computing companies (large broad-based companies that indirectly utilize or support the use of cloud computing technology).

This is important because the fund looks to tilt towards the pure play companies and away from those that have little exposure to the industry. As such, 10% of the index weight is allocated to technology conglomerate companies and the rest is divided among the more cloud-focused firms. This remainder is allocated to non pure play companies by dividing the non pure play companies’ market capitalization by the sum of the pure play, non pure play, and technology conglomerate market capitalizations. Then, the remainder of the index weighting is allocated to pure play firms. Stocks are equally weighted within each of the three classifications and the index is reconstituted and rebalanced semi-annually (read Alternative ETF Weighting Methodologies 101).

With this makeup, the fund has a tilt towards companies in the software (33.4%), internet services (22.3%), and communications equipment (17.4%) segments of the technology sector. Top weightings include Akamai Technologies (AKAM - Free Report) , Juniper Networks (JNPR - Free Report) , and Google , although it should be noted that the top ten holdings make up just 35% of the portfolio suggesting that assets are well spread out among the component companies. Beyond this holdings information, it is also important to note the characteristics of the companies in the basket as there is a definite push towards growth firms. In fact, the P/E is close to 24.4 while the Price/Sales is 3.3, far above more diversified firms even in the tech space.

So if investors are searching for a growth story in this uncertain market, SKYY could be worth a closer look. While the fund is likely to be more volatile than its counterparts in the tech world, it will be hard to find another fund, focused on the U.S. space, which has such quality prospects for growth. As a result, a small allocation to the sector could be warranted by most investors, especially if one is already underweight in the technology sector (also see Inside The Guggenheim Spin-Off ETF).

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