Cloud computing ETFs are surging, but should investors bet on the niche play long term?

Source:-https://www.theglobeandmail.com

Cloud computing ETFs have benefitted from the historic shift to working-from-home and distance learning brought about by the COVID-19 pandemic, though some providers expect the surge to continue long after the global health crisis ends.

“This has been a phenomenal year for cloud computing stocks, they have been extremely well positioned in this environment,” said Jay Jacobs, senior vice-president and head of research and strategy for Global X Management Company LLC, which first launched its Global X Cloud Computing ETF (CLOU-Q) in April 2019. The ETF has surged by about 60 per cent in the past year.

Other cloud-based ETFs such as the Wisdom Tree Cloud Computing Fund (WCLD-Q) and First Trust Cloud Computer ETF (SKYY-Q) have risen by about 80 per cent and 45 per cent, respectively, over the past year.

“The reason why we continue to remain very bullish on the space is because preferences really have changed,” Mr. Jacobs says. “Yes, we will have a vaccine that will ultimately get distributed and there will be a post-pandemic life at some point, but from what we can tell in terms of surveys and announcements from different companies, is that use cases for cloud computing are not going away.”

Now that people have incorporated these software-as-a-service platforms into their work and personal lives, Mr. Jacobs says “there is a real stickiness to it, where you don’t want to go back to your old ways of doing things.”

ETF provider Evolve Funds Group Inc. chief executive office Raj Lala agrees the pandemic has accelerated the use of cloud computing, “but it has also resulted in a long-term behavioural shift.”

Mr. Lala cites e-signature platform DocuSign Inc. as an example. “Now that people have started to use DocuSign, do you really think companies and individuals are going to go back to printing a document, signing it and sending it back? Probably not,” he says.

Providers take a wide range of approaches in selecting the individual companies to include in their cloud ETF products. Some focus more on physical cloud infrastructure such as data centres and server makers while others are more heavily weighted toward cloud-based services such as video conferencing, enterprise software and virtual private network (VPN) companies.

Evolve used to include cloud computing as a component in its Evolve Innovation Index ETF (EDGE-T), but Mr. Lala said the sector has now “run into the size where it really does merit its own fund.”

Evolve plans to launch what it calls Canada’s first cloud-computing ETF, the Evolve Cloud Computing Index Fund (DATA-T), which submitted a preliminary prospectus to securities regulators Nov. 12 and will set a date to begin trading after receiving final approval.

While Canadian investors and advisors can access the U.S.-listed [cloud computing ETFs], they will have to invest in U.S. dollars,” Mr. Lala says, “whereas with our fund you would be able to invest on a currency-hedged basis, which for a lot of people is pretty important.”

While DATA is set to be the first Canadian ETF with ‘cloud’ in its title, Nick Mersch, an associate portfolio manager at ETF provider Purpose Investments, argues Canadian investors already have multiple ways of gaining exposure to the sector using their own currency.

“There is a lot of a marketing component” behind Evolve’s claim of launching DATA as Canada’s “first” cloud computing ETF, says Mr. Mersch, who runs the Purpose Global Innovators Fund (PINV-T), a technology fund with an ETF structure that takes a broader approach. The fund is up about 40 per cent over the past year.

“Cloud and AI [artificial intelligence] and automation are our main themes, but with an enterprise software core holding, and since a lot of these applications are indeed built in the cloud there is a lot of overlap,” he says.

“You really need to have a zoom-out lens about whether it is just a specific cloud-based application, or do these software companies actually touch everything else?”

Choosing the right cloud computing ETF can be more challenging because “there is no S&P 500 of cloud computing or of battery technology or of robotics,” says Mr. Jacobs of Global X. “With all thematic ETFs, there is a lot of work that goes into the backend of designing the index [and] really scoping out what is the theme and how are we going to access it.”

Among the key differentiators is how the different cloud computing ETFs account for the elephants in the room: tech giants such as Google, Amazon, Microsoft and IBM that dominate the cloud computing industry despite only earning a fraction of their overall revenues from offering cloud services.

“What we have done is specifically include exposure to those companies, but capped them so that in aggregate they [represent no more than] 10 percent of our fund,” Mr. Jacobs says of CLOU. “That is a pretty good differentiator for us because I think a lot of our competitors often include those companies at a much bigger weight.”

As cloud services become increasingly essential, some have compared investing in cloud ETFs to buying utility stocks.

“The difference with utilities though is utilities are regulated on the pricing side,” Mr. Jacobs says. “The reason why that is important is because, for cloud computing, it is really a fixed cost business, so as they add more users or increase prices it is really additive to their earnings.”

“In 2020, the Zooms of the world and the Salesforces of the world were adding clients very quickly and knew the economy was bad so they gave [lower] prices to get people into the system,” he says. “Starting in 2021, due to the fixed-cost nature of their businesses, they are going to have a lot of power to raise prices and a lot of companies are just going to have to eat that cost.”

That trend is only half of the bull case behind cloud computing ETFs, with Mr. Lala noting “increasing connectivity” more broadly is also positive for the sector.

“We have added one billion people online just in the past year; in 2019 just over four billion people had Internet access and today over five billion people are connected online,” Mr. Lala says. “You are definitely seeing a massive shift of people moving online and that is what cloud-based technology is all about.”