Cloud Computing ETF: The SKYY's the Limit

The last several years have seen no shortage of firsts in the ETF industry. The size of the ETF roster is quickly approaching 1,300 products, thanks in large part to impressive innovation from more than three dozen different issuers. While some of the new launches have been duplicative in nature, the vast majority of the new additions are first-to-market ideas offering exposure to asset classes or investment strategies that weren’t previously available in the exchange-traded wrapper. 

The list of firsts from the first half of this year alone is mind-boggling; we've seen Canadian preferred stock (CNPF),mid-cap Japanese stocks (RSUN), and an ETN focusing on Business Development Companies (BDCS), just to name a few. Last week saw yet another first that some though would never come -- and perhaps the most successful new ETF launch of 2011 to date; First Trust debuted an exchange-traded product designed to give investors exposure to the cloud computing industry, and investors responded to the fund with record trading volumes.

Cloud Computing ETF: SKYY
The First Trust ISE Cloud Computing Index Fund (Nasdaq: SKYY  ) is linked to a unique benchmark that includes everything from small relatively new tech companies to established giants such as Microsoft (Nasdaq: MSFT  ) , Apple (Nasdaq: AAPL  ) , and Google (Nasdaq: GOOG  ) . The methodology behind the index includes both "pure play" cloud computing companies that focus their operations on this emerging technology, as well as firms that derive only a portion of their revenues from the space or are more tangentially involved in "the cloud" [see also Up in the Clouds: First Cloud Computing ETF Debuts].

The days leading up to the launch saw a fair amount of skepticism over the level of demand for such a hyper-targeted product. But once the opening bell rang, it quickly became apparent that First Trust was tapping into a corner of the tech market that investors had been anxious to access. Unlike other narrowly-focused products such as the Smartphone Index Fund (Nasdaq: FONE  ) , which has only about $16 million in assets, SKYY came flying out of the gates and quickly began to build what seems likely to be a substantial base of assets. SKYY traded an aggregate of over one million shares in its first two days on market, and quickly blew past the $10 million mark that many new ETFs take months to clear.

Cloud computing is a buzz word in tech circles, and the hot start to SKYY shows that investors are clearly anxious to get a hand in a market that is likely to experience significant growth in coming years. What remains to be seen, however, is just how the growth of the cloud translates into growth in the bottom lines of the companies that make up SKYY. The answer to that question is, well, a bit cloudy.

Cloud Computing: A Brief Overview
Few investors have a firm grasp on exactly what cloud computing is and how best to define the budding industry. First off, the term cloud computing was derived from the visual representation of the industry, which often resembles a cloud. Though one could literally write a book on all of the nuances that go along with cloud computing, the short and sweet version is that this term refers to anything that involves offering and delivering services over the Internet. This industry can be broken down into three broad categories: infrastructure-as-a-service, platform-as-a-service, and software-as-a-service.

Infrastructure-as-a-service involves virtual storage and other hardware services to businesses and individuals without requiring ownership of any mainframes or hardware. Platform-as-a-service involves development tools and software offered by a provider who stores and maintains the actual infrastructure -- GoogleApps would be a well known and widely used example. Software-as-a-service includes products offered through the cloud to anyone who wants them; this category includes functions such as Google Docs or even many email providers (some versions of the cloud have been around and in use for many years). Software-as-a-service would also include Microsoft Office, which the company just announced it would be offering in an effort to compete with Google in this increasingly important space.

Advantages to the Cloud
Cloud computing can offer a wealth of advantages in today’s economy. Clouds can be both public and private to restrict or allow access to as many people as needed, whether you are a small business restricting access to only your employees, or a major company offering software to anyone willing to buy it. The cloud is generally used as a pay-as-you-go service, where the user only pays for what they are consuming, and can very easily add or decrease services. So if all of your pictures were stored in a cloud device and you wanted to add another 1,000 photos to your account, you would simply pay more for the new memory that you would be using. The best part of the cloud is that, theoretically, all one needs is a computer and internet access, no expensive hardware or hassle beyond finding the services that you wish to use [see also Why Chinese Technology ETFs Are Crushing the Competition].

What's Next?
Many analysts agree that cloud computing will grow significantly in the coming years as companies and individuals start to see the benefits that this industry can offer. According to research company IDC, spending on public cloud computing services will grow five times faster than global IT spending in 2011. Another promising statistic for the industry is the growth in availability of high speed Internet access. As Internet access becomes more widespread across the world, the cloud industry will gain significant potential, as companies can begin to push their services internationally in areas that may not have been worth considering just years earlier thanks to the cost savings of the cloud.

The big question relates to just how well SKYY will capture the industry's growth in coming years. While several components are pure play cloud computing companies, the roster also includes bigger companies that have core operations focusing on search engines, personal computers, and even cell phones. While the cloud figures to account for a larger and larger portion of those companies' revenues going forward, it may never be the primary driver in many cases.

That’s the challenge in building an investment product to offer exposure to a new technology or trend; coming up with a group of securities linked purely to the success or that theme can be challenging. SKYY is certainly an innovative product, and a creative way to invest in an exciting new corner of the market. Only time will tell if it's a good long-term investment idea for those who have been snapping up all the shares they can get.

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