If we’ve learned anything lately, it’s that tech continues to be dominant. The sector was a leader before the novel coronavirus came along, and it has been the leader since. While some industries have been better than others, software and cloud stocks have been impressive. Because of that, investors should look at software ETFs this month.
Many tech stocks have enjoyed a monstrous rally from the March lows, soaring into summer. While there was some resting in between, in general, the group continued higher into September before topping out and correcting lower.
That correction led to many great opportunities in the space, and now tech stocks are putting together a strong rebound in October.
Did investors miss their chance to get long? Not if the market is going to new highs.
Let’s look at seven of the top software ETFs to buy:
- SPDR FactSet Innovative Technology ETF (NYSEARCA:XITK)
- Renaissance IPO ETF (NYSEARCA:IPO)
- SPDR S&P Software & Services ETF (NYSEARCA:XSW)
- iShares Expanded Tech-Software ETF (BATS:IGV)
- First Trust Cloud Computing ETF (NASDAQ:SKYY)
- Global X Cloud Computing ETF (NASDAQ:CLOU)
- Invesco Dynamic Software ETF (NYSEARCA:PSJ)
Software ETFs: SPDR FactSet Innovative Technology ETF (XITK)
Expense Ratio: 0.45%, or $45 on an initial $10,000 investment
There are a lot of choices out there when it comes to ETFs. In fact, the choices seem nearly endless. Those who want broad exposure to the tech space may consider the Invesco QQQ Trust (NASDAQ:QQQ).
For those that want specific exposure, the SPDR FactSet Innovative Technology ETF should be a consideration. At least, it should be a consideration for investors looking at software ETFs.
In fact, a year ago I picked the XITK as my top pick in InvestorPlace’s Best ETFs for 2020 contest. Through the first three quarters of 2020, it sits in third. But what I really like about it is its performance vs. the broader market.
Specifically, the XITK has massively outperformed the QQQ ETF on the upside. That outperformance goes for this year, this quarter and the trailing 12 months. But it also goes for the past three years and five years as well.
But that’s not the best part. Instead, it’s the fact that when the markets are getting crushed, the XITK trades in a similar manner to the QQQ. When the latter fell 32.6% from peak to trough during the coronavirus selloff, the XITK “only” fell 36.5%.
That’s about 390 basis points of underperformance. However, from the coronavirus lows, the XITK has surged 126.1% vs. the QQQ rally of “just” 78.6%.
I’ll take 400 basis points of underperformance at the dead lows for 4,750 basis points of outperformance on the rally.
Renaissance Capital IPO ETF (IPO)
Expense Ratio: 0.6%
The ETF that currently leads the contest is the Renaissance Capital IPO ETF. As well as the XITK is doing — up 60% in 2020 — it lags the IPO ETF, which is up 76%.
As one might expect, there are stark differences between the two funds. However, there are also commonalities found between the two. For instance, both hold Zoom Video (NASDAQ:ZM) as the top holding in their portfolios. Both are also heavily exposed to software companies and young tech stocks.
However, the IPO ETF has roughly twice as much exposure to Zoom when it comes to portfolio weighting. The stock makes up almost 11% of the IPO ETF vs. just 5% for the XITK.
Further, the IPO ETF has 54% of its portfolio tied up in its top 10 holdings. As you can see by this year’s outperformance, that has been a good thing. However, should just a few of its top stocks underperform, the entire ETF could suffer as a result. For the XITK, its top holdings make up just 24% of the portfolio’s weighting.
In any regard though, the IPO ETF has been seriously strong in 2020. There’s a reason it leads the ETF contest through the first nine months of the year. Until investors’ appetite for new stocks dies down, this one likely won’t either.
Software ETFs: SPDR S&P Software & Services ETF (XSW)
Expense Ratio: 0.35%
Those looking for software ETFs would seemingly have to run into the SPDR S&P Software & Services ETF, if not for the name alone. I find the weightings in the ETF to be very peculiar, though.
While the IPO ETF has heavier weightings to its top stocks and the XITK has less, the XSW has a minuscule weighting to its top picks. Its top 10 stocks make up just 7% of the fund’s weighting.
In other words, this is an equal-weight fund, where the company distributes roughly the same allocation to each holding. This has its pros and cons. While diversity helps keep investors’ exposure to single-stock risk to a minimum, it can also result in disappointing returns.
For instance, look at how well the IPO ETF has done as it lets its winners run.
But the XSW’s strategy isn’t without merit. Even with that diversity, the ETF should still do well provided the tech sector does well. Plus, it won’t fall victim to any one or two stock’s individual performance.
iShares Tech-Software Sector ETF (IGV)
Expense Ratio: 0.46%
Thus far our list has consisted of software ETFs with exposure to mid-cap tech stocks and newcomers that have had enormous success in light of the coronavirus. However, we shouldn’t forget about the iShares Tech-Software Sector ETF.
The iShares Tech-Software Sector ETF has exposure to the companies investors know best. For instance, its top three holdings include Adobe (NASDAQ:ADBE), Microsoft (NASDAQ:MSFT) and Salesforce (NYSE:CRM).
All three of those stocks have a roughly equal weighting in the portfolio, near 8%. These are well-known tech stocks, some of which command a mega-market capitalization north of $1 trillion.
I really like the IGV ETF for several reasons. First, it boasts strong returns and solid long-term results. It’s got a great combination of quality, large-cap growth stocks as its top holdings. However, its other top holdings are also solid growers with good opportunities in the years ahead — like Zoom and ServiceNow (NYSE:NOW).
Lastly, it beats the market. The IGV ETF boasts a three-year average return of 29%. Over the past 10 years, that average is 20%.
Software ETFs: First Trust Cloud Computing ETF (SKYY)
Expense Ratio: 0.6%
The First Trust Cloud Computing ETF is another name that comes to mind in the cloud space. As the name suggests, we’re turning to the “SKYY” and focusing on cloud-computing.
Some investors thought the cloud revolution might only last a few years and be a low-profitability venture. That’s turning out to be quite false. We now have multiple layers of the cloud forming and multiple companies reaping the rewards.
While there are some slower growth names in there, I really like the exposure to Alibaba, Microsoft and Amazon (NASDAQ:AMZN). Alibaba is a dominant player in China and its cloud business is coming along great. Microsoft and Amazon are the two more dominant players in the U.S. cloud market.
Put it all together and investors have an ETF with solid cloud exposure from high-quality companies. It may lack the explosive upside from some of the smaller software stocks. However, this high-quality group can lead, and it at least has some protection on the downside.
Global X Cloud Computing ETF (CLOU)
Expense Ratio: 0.68%
For those wondering what fund sits between the XITK at No. 3 and the IPO ETF at No. 1 in the top ETF contest, it’s the Global X Cloud Computing ETF. The ETF has done well this year, generating a 60% return.
It’s similar to the SKYY ETF, but is different in many ways. For instance, the SKYY ETF has about 37% of its portfolio spread out across its top 10 holdings. The CLOU ETF has more than 52% of its portfolio in the top 10.
Further differentiating the CLOU ETF is its selection of stocks. Where SKYY favors large- and mega-cap tech stocks, CLOU seems to prefer mid- and large-cap stocks. Or at least it did prefer them before they increased so much.
For what it’s worth, CLOU has been a dominant force this year. It’s sharpe ratio of 1.85 suggests that investors have been well compensated for their risk. A 37% annualized return since inception also stands out.
The downside is that the fund is barely more than a year old, having launched in April 2019. It’s hard to compare its performance and longevity to other names on this list.
Software ETFs: Invesco Dynamic Software ETF (PSJ)
Expense Ratio: 0.56%
Lastly, I want to look at the Invesco Dynamic Software ETF. I was tempted to go with a broader ETF, but there are some things I really like about this one.
First, I like that there’s a lot of history with this name. It was incepted in June 2005, so we’ve got more than 15 years of history to comb through. In the last decade, the PSJ has had just one year where it lost value, falling 6% in 2011.
For comparison purposes, the QQQ has also advanced in nine of the last 10 years. However, in 2011 it was able to gain 3.4% when PSJ fell. Instead, it was 2018 that weighed on the ETF, as it finished lower by about 12 basis points. While that’s basically flat, the PSJ climbed more than 16% that year.
The PSJ boasts three-, five- and 10-year average returns of 26%, 25.3% and 18.7%, respectively. That last one in particular stands out.
I also like the way its top holdings are constructed. In an interesting twist, Snap (NYSE:SNAP) is the top holding, with a 6% weighting. Shopify, Activision Blizzard (NASDAQ:ATVI) and DocuSign (NASDAQ:DOCU) round out some of the other top five holdings. Microsoft and Adobe are also in the top 10.
Other notes to include would be the ETF’s low volume. Over the last ten days, the ETF has an average trading volume of about 20,000 shares. That’s very low and can be a problem for some investors, particularly those that require liquidity or trade in and out of the positions on a semi-regular basis.
On the date of publication, Bret Kenwell held a long position in SHOP and DOCU.