Cloud Hosting

Source: ParkMyCloud.com

The First Trust Cloud Computing ETF (SKYY) isn't as heavily weighted in the stocks of companies that first jump into most investors' heads when they think of "the cloud". Most investors would assume a cloud-focused ETF or mutual fund would be over-weighted in the holdings of the "Big-3" leading cloud providers Microsoft (MSFT) for its Azure platform, Amazon (AMZN) for its AWS business, and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) for its Google Cloud ("GCP").

Regardless, SKYY - which seeks to track the "ISE CTA Cloud Computing Index" - is up 26% YTD and 150% over the past 5 years (not counting dividends).

And to be sure, SKYY holds the Big-3 companies in the fund, just not to the level you might have thought - or perhaps desired. Let's take a look at the top-10 holdings as of last week (8/14/2020):

Source: First Trust

As can be seen from the graphic above, SKYY's top-10 holdings have an aggregate 36.76% total allocation. Within that group, the Big-3 have an aggregate weighting of ~13%. That might surprise some investors, considering the relative market share the Big-3 have in the cloud. As the graphic below shows, in Q1 2020, the Big-3 providers accounted for a whopping 55% of total global infrastructure spending:

Source: Canalys.com

Alibaba (NYSE:BABA) had a 6% share and is the second biggest holding in the SKYY ETF with a 4.6% weighting, much more in line with its market share as compared to the Big-3. This relative weighting might indicate the SKYY portfolio managers may be thinking:

Investors should ponder these issues and consider what their comfort level is with various valuation levels, growth expectations, regional considerations, and the associated risks.

Regardless of the relative weighting of the biggest cloud service providers, one thing is clear: growth in global cloud service revenue is nowhere near slowing down. As the graphic below demonstrates, virus or no-virus (note this was a July 2020 forecast), cloud service revenue is expected to grow 19% next year and another 18% in 2022 versus 2021. Or, looking at it in raw numbers: revenue in 2022 is expected to be ~$106 billion higher than full-year 2020 expectations.

Source: Gartner July 2020

Note that the "Others" category in the previous market share graphic held a 38% slice of the global cloud service pie. That, combined with Gartner's growth projections, means that some of the smaller players held in the SKYY ETF will have plenty of opportunities to grow.

Oracle Corporation (ORCL), the #5 holding, and its cloud-related revenue was relatively flat year over year (see Q4 and FY2020 EPS report). The stock is also flat YTD. So, it's clearly been an under-performer while yielding ~1.8%. But Oracle is up nicely in the pre-market today due to speculation the company is teaming up with private equity to challenge Microsoft's (MSFT) bid for Tik-Tok.

Fastly Class A (FSLY) is the #7 holding and is up a whopping 280% this year on the heels of fast growing revenue and market acceptance of its security and cloud products. VMware (VMW), the #8 holding, is down YTD and is the technology much of Oracle's cloud-based solutions are tethered. Interesting that both those companies are relatively flat this year.

Arista Networks (ANET) holds down the #9 position and has also been a relative laggard with poor YoY comparisons.

The downside risks should not be sugar-coated (just look at the chart at the end of the article for what happened in March):

Alibaba may face some headline risks due to the ongoing trade battle between the US and China. That said, Alibaba's position in China is not going to be affected much, and if the company needs to remove its US exchange listing, there are a number of other exchanges that would be happy to host the company.

Upside risks include continued big-tech domination in the overall market, acceleration of the work- and school-from-home trends that could lead to more cloud-related activity, and an acceleration of digitization in general due to the 5G rollout, which should be rapidly accelerating over the next 2-3 years, at a minimum.

While SKYY holds solid positions in the Big-3 cloud service providers, they are under-weighted in comparison to their cloud market share. But that might be just fine for investors who feel they are over-valued in today's market. Alibaba is more equally weighted in the fund as compared to its cloud market share, and that might be exactly what an investor who thinks China may grow faster than the US wants to see. Regardless, the global cloud market is set to grow by over $100 billion over the next two years, and that gives the ~60% of the companies that aren't in SKYY's top-10 holdings plenty of opportunities to grow.

Bottom line: SKYY has an excellent 1-year and 5-year track record (see chart below) of performance and is well worth the 0.60% expense ratio.

Source: Seeking Alpha

Disclosure: I am/we are long AMZN, GOOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

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SKYY: A Cloud Computing ETF Not Overly Concentrated In The Big-3 - Seeking Alpha