Is Facebook (FB.O) a tech company or a communications platform? Is Amazon (AMZN.O) an e-commerce giant or a cloud megastar (with its Amazon Web Services business)?
Earlier this year the big index firms behind the GICS – a global industry classification system – moved a bunch of tech giants out of the tech ‘bucket’ and into the communications sector. Overnight this latter sector ended up boasting everyone from Facebook through to Netflix (NFLX.O).
This proposed new classification system only kicked in at the beginning of September, but my guess is that most investors probably didn’t even notice. That’s because more and more investors have given up caring about traditional industry classification systems and choose to focus more on trend-based themes. These thematic strategies, easily implemented by index tracking exchange traded funds, tend to be cross traditional sector classifications in search of businesses jumping on board a big trend-based bandwagon.
The simplest way of seeing this in action is to look at the cloud. One could argue, erroneously I think, that Facebook and Google are just as important to the future of the cloud as, say, pure-plays working within this space such as Dropbox (DBX.O) and Amazon (more on that below). But what I think we can all agree on is that when it comes to corporates and what they spend their money on, the cloud really does matter. I’ve seen fairly conservative estimates which suggests that anything between 30% and 50% of all IT/tech spending is devoted to stuff with strange acronym-based labels such as Saas (software as a service) or Paas (Platform as a service).
This huge move to sending corporate data into remote servers is even hitting the consumer sphere – I’ve given up backing up most of my files to a DVD and now use multiple cloud-based servers. Multiple? Because you never know when one cloud based back up might shut down, backing up backups becomes essential. Curiously I also used to be a fan of Dropbox but now think that OneDrive is the bee’s knees – owned by Microsoft (MSFT.O). In my personal experience the Office 365 service is worth it just for OneDrive.
We’re also seeing new terms emerge such as the hybrid cloud, where corporates mix and match public and private clouds, all with a focus on top level cyber security. Given all these new products, it's no wonder that public cloud revenues rose at a compound average growth rates of 34% per annum between 2007 and 2017. And the biggest player so far? Amazon, via its Amazon Web Services business which accounts for more than half of the e-commerce giants’ net revenues.
So the vast majority of businesses within the cloud space do fall into the general technology sector definition but that’s where neat distinctions start to fade away. Many of the most interesting businesses involved in the cloud fall firmly in the software space, whereas arguably the most profitable businesses produce hardware, making the picks and shovels of the tech revolution. Some, such as IBM (IBM.N) post its massive takeover of Redhat, straddle software and consulting.
If you want to capture big themes like the cloud – and I think this is one of the most compelling thematic ideas out there – you need to be flexible about how you define the most interesting businesses. Arguably this gives well known active fund managers in this space such as Polar Capital the greatest flexibility, as they can simply define their end game (the best cloud companies) and then buy the businesses they like. For index tracking exchange-traded funds (ETFs) it gets trickier, as the vast majority follow broader classification systems. But what happens if you want a purer way to play the trend?
Cue the rise of thematic ETFs, which are springing up all the over place to capture these big trends. One of the newest is called the HAN-GINS Cloud Technologies Ucits ETF (SKYY), which has been listed on the London market for about four weeks.
This is still a very small fund from a new issuer – HAN ETF specialises in working with existing fund managers to bring out innovative new index tracking funds, many related to a big theme. The company providing the strategy behind the ETF is called GINS Global and has been running various index-based strategies for a number of years.
This particular cloud index would have produced returns of 31.8% in 2018. In 2016 returns would have been 14.8%. The ETF itself has a total expense ratio of 0.75% and caps its individual holdings at a maximum level of 4% - otherwise the index (managed by a specialist firm called Solactive) is market cap weighted.
Top holdings within the fund include some obvious names such as Amazon, Salesforce (CRM.N), IBM/Redhat as well as Microsoft but you’ll also find Apple (AAPL.O) in there (they’re growing their cloud business at a rapid rate) as well as hardware manufacturers such as Cisco (CSCO.O) (servers) and Nvidia (NVDA.O) (graphics processing units).
One challenge with this broad thematic approach is that you end up including tech businesses where the cloud is only a small part of their existing ‘legacy’ business – Apple is a prime example. But my hunch is that Apple will end up becoming a huge player in the cloud, with a particular focus on client privacy and cyber security.
The other, obvious, challenge to this fund is timing – the ETF emerged just as tech stocks sold off. There’s no getting away from the fact that many of the biggest names in this space were, and still are, overvalued.
But as a long-term play, I think the cloud is where you need to be and so this could be a useful buy and lock away fund, waiting to be picked up at much cheaper price after the next big sell off, which is bound to happen at some stage in the next few months.
The other alternative is to stick with familiar and well-known active alternatives such as the Polar Capital Technology (PCT) or Scottish Mortgage (SMT) with its focus on global tech enabled platform businesses – both of these funds love the cloud as just one of multiple strategies. But if you want a pure tracker fund, this is certainly worth a closer look.