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Summary SKYY delivers exposure to companies in the cloud computing space. The definition of a cloud computing company includes everything from technology providers to game companies that use the technology. The result is a broad technology portfolio that lacks the pure exposure investors may be after. Cloud computing is transforming the information technology landscape. It offers companies numerous advantages, including enhanced agility and dynamic scalability as well as the potential for significant cost savings. This technology has been growing rapidly and that pace is expected to continue. Investments in key strategic areas like enterprise mobile, big data analytics and information security is expected to increase significantly over the next few years. Analysts at Market Research Media estimate that the global cloud computing market will grow 30 percent compounded annually over the next five years to reach $270 billion. This likely growth in the cloud-based computing sector offers investors an opportunity to reap tremendous rewards. First Trust ISE Cloud Computing Fund The First Trust ISE Cloud Computing Index ETF (NASDAQ: SKYY ) seeks to provide results that generally correspond with the price and yield of the ISE Cloud Computing Index. This exchange-traded fund normally invests at least 90 percent of assets in common shares or depository receipts issued by companies contained within the index. The ISE Cloud Computing Index is designed to provide a benchmark for investors tracking companies principally engaged in the cloud computing industry. To be included in the benchmark index, securities must be listed on a global exchange and be engaged in a business activity providing, supporting or utilizing cloud computing services. Securities are classified as pure cloud computing companies and non-pure play companies whose focus is outside the cloud computing space but still have a significant exposure to the industry. The sector also includes technology conglomerates that may indirectly utilize or support cloud computing technology. In addition to a 10 percent allocation in technology conglomerates, managers use a calculation based on the relationship between the market capitalizations of the pure and non-pure play companies to determine their respective allocations. The underlying index then uses a modified equal dollar-weighted average approach when balancing the portfolio semiannually. SKYY is a three-star Morningstar rated ETF with $468.24 million under management. As of October 4, the fund had a 94 percent exposure to domestic equities and a 6 percent allocation of foreign shares, mostly in developed Europe. Weighted heavily towards the technology space, SKYY also held a small position in consumer cyclical and communications services companies. The ETF had a 33 percent allocation to giant cap companies as well as a 22 percent and 35 percent exposure to large and mid-cap shares. There is also a 6 percent and 4 percent allocation to small- and micro-cap shares. The fund’s average market capitalization is $27.7 billion. The portfolio has a P/E ratio of 24 and a price-to-book of 3.8 according to the issuer’s website . The portfolio’s top 10 holdings comprise 43 percent of assets. Companies held in the fund include Amazon (NASDAQ: AMZN ), Google (NASDAQ: GOOG ), Netflix (NASDAQ: NFLX ), Facebook (NASDAQ: FB ) and Open Text (NASDAQ: OTEX ). As the top holding, Amazon has been a driving force behind the fund’s performance in 2015. While predominately known as an e-commerce site, Amazon generates more than $4.5 billion in revenue from its cloud-based services. Although cloud services account for less than 10 percent of Amazon’s total revenue, it is the fastest growing segment of the company’s overall business. The Amazon Web Services (AWS) business unit grew 49 percent in 2014 and 81 percent during the second quarter of 2015 on an annualized basis compared to the 26 percent growth in North American retail sales. While the company’s retail operation is losing money, AWS is very profitable. At 21 percent, it provides significantly higher profit margins when compared to other business units. The profit margin for AWS has continued to rise despite price competition from competitors like Google, IBM (NYSE: IBM ) and Microsoft (NASDAQ: MSFT ). One of the first to enter the cloud computing space, Amazon has a lead on its competitors. To stay ahead, it is expanding services to include tools for analyzing data stored on their servers, building new online software applications and increasing storage space. Based on a belief that the future is in the cloud, Amazon has been investing billions of dollars building and expanding centralized data storage centers. Eventually, Amazon’s cloud computing unit may become the largest business segment within the company. SKYY’s 1- and 3-year total returns are 6.29 percent and 13.27 percent respectively, as of October 4, which compares to the technology category returns of 4.92 percent and 14.93 percent over the same periods. SKYY has a 3-year beta and standard deviation of 1.08 and 14.09. The equivalent period ratings for the science and technology category are 0.98 and 13.87. The ETF’s net expense ratio of 0.60 percent is slightly higher than the category average of 0.57 percent. This chart shows the performance of SKYY and the Technology Select Sector SPDR ETF (NYSEARCA: XLK ). The two are highly correlated as one would expect, but the relative can be substantial. The second chart, the price ratio of SKYY versus XLK, shows that performance has swung between under- and outperformance, but without any consistent pattern. (click to enlarge) (click to enlarge) With a lot of big Internet names in the top holdings, it’s worth considering an Internet fund as well. Here’s the price ratio of SKYY versus the First Trust DJ Internet Index ETF (NYSEARCA: FDN ), which has substantial overlap in holdings. The funds track closely in terms of performance, tied as they are to the overall technology sector, but FDN has been a more consistent winner. (click to enlarge) Outlook As sometimes happens with sub-sector funds, the definition of a cloud computing company is stretched to create a full portfolio here, with several companies that are cloud users rather than backbone companies that provide the technology. With cloud services becoming a major part of the Internet business, it is also becoming difficult to separate out pure play companies. The result is a portfolio that looks a lot like an Internet or broader technology fund. Performance aside, the big strike against SKYY is the large weighting of familiar Internet companies found in most broad technology funds. SKYY isn’t offering the unique exposure that investors may think they’re getting. Investors looking for pure exposure to cloud computing would be better off holding individual stocks, and sticking with Internet or broad technology funds for the rest of their technology exposure.