Cloud Computing ETF Trend Continuing

Key Takeaways

• In 2020, the surge in remote access requirements and the overall economic pressure brought by COVID-19 accelerated cloud migration for all types of enterprise applications. CFRA expects continued strong revenue growth and operating margin expansion for companies with meaningful cloud exposure, including Salesforce (CRM) and New Relic (NEWR).  
• Yet after gathering $3.3 billion of net inflows in 2020, demand for thematic ETFs like the First Trust Cloud Computing ETF (SKYY), the Global X Cloud Computing ETF (CLOU) and the WisdomTree Cloud Computing Fund (WCLD) has waned in 2021.
• Despite limited overlapping holdings, CFRA has five-star ratings on these leading thematic ETFs, believing they will outperform their broader equity categories in 2021.

Fundamental Context

Cloud computing lowers the total cost of a given application by eliminating the IT infrastructure costs required to keep that app securely up and running. According to CFRA Equity Analyst John Freeman, cloud computing initially gained popularity among small- to medium-sized businesses.

However, in the aftermath of the 2008 financial crisis, large enterprises began migrating applications in categories like customer relationship management to cloud providers such as CRM.

In 2020 and 2021, the surge in remote access requirements and the overall economic pressure brought by COVID-19 has had a similar catalyzing effect, accelerating cloud migration for all types of enterprise applications.

According to the International Data Corporation, cloud subscriptions accounted for just 33% of total enterprise software revenue in 2019. Freeman estimates that percentage likely jumped to ~40% in 2020, and is not likely to hit 50% until 2023. Meanwhile, he thinks many cloud app providers are likely to realize operating leverage and grow profitability even faster than revenues.

Demand for cloud computing ETFs has slowed in 2021. In 2020, cloud computing thematic ETFs generated strong investor interest as an abrupt shift to a work-from-home environment sped up the longer-term trend.

Last year, cloud computing software sales accelerated as companies and consumers turned to internet-based software-as-a-service solutions like videoconferencing.

Chart 1: Leading Cloud Computing ETF Flows ($M)

Source: CFRA’s First Bridge ETF Database, as of March 5, 2021

The three largest cloud computing ETFs—CLOU, SKYY and WCLD—gathered $3.3 billion of net ETF inflows, and aided by strong returns, ended 2020 with $8.9 billion in assets. However, year-to-date through March 5, the trio had net outflows of approximately $100 million. Meanwhile, ETFs offering exposure to themes such as cannabis and infrastructure have been much more popular in 2021.

Long-Term Themes

Thematic ETFs are designed for the long-term investor. According to Jay Jacobs, head of research and strategy for ETF provider Global X, thematic investing should take a research-driven approach to identifying powerful macro level trends, accurately targeting a comprehensive list of companies that stand to benefit from the materialization of that trend and be implemented over a long time frame to maximize the opportunity to capture its growth potential.

Jacobs adds that investors should play the adoption curve, not the hype cycle. Themes such as cannabis, cloud computing, cybersecurity, e-commerce, fintech and infrastructure development are still early in the adoption cycle, with significant room for growth in the addressable market. 

CFRA remains positive on leading cloud computing ETFs, despite holdings differences. The $1.6 billion SKYY is the largest of the trio and the oldest, launching in 2011. However, the $1.4 billion CLOU and $1.2 billion WCLD came to market in 2019, and provided investors with alternatives.

In 2020, WCLD more than doubled in value, outperforming CLOU’s and SKYY’s gains of 74% and 55%, respectively. However, year-to-date through March 5, SKYY’s 0.3% loss was narrower than CLOU’s 8.7% and WCLD’s 9.4% declines, a reminder that past performance is not necessarily indicative of future results.

CLOU, SKYY and WCLD all earn CFRA five-star ratings, which is indicative of the high likelihood of outperforming their equity category over the next nine months. Our ratings combine holdings-level analysis with fund attributes, including performance and costs.

Chart 2: Performance Record of Leading Cloud Computing ETFs (%)

Source: CFRA’s First Bridge ETF Database, as of March 5, 2021

CFRA thinks SKYY provides high reward potential, while CLOU and WCLD provide more risk mitigation than the larger peer. However, the holdings of these three ETFs are very different, as there are just 16 securities held in common among all three funds, including CRM and Zoom Video Communications (ZM).

That said, CLOU is alone in owning Netflix (NFLX), while SKYY is the only one to have a stake in VMware (VMW). Investors seeking out smaller cap software company NEWR would currently find it exclusively in WCLD.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

Conclusion

CFRA thinks the cloud computing trend has significant room for growth, and believes investors have some strong ETFs that offer diversification benefits to consider. While the 2020 returns are not being duplicated to start the new year, CLOU, SKYY and WCLD are appealing to CFRA based on risk, reward and cost factors.

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. For more information and disclosures, please refer to CFRA's Legal Notice at https://www.cfraresearch.com/legal/.

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