Cloud computing has shifted so gradually from being an innovative concept in the development of the internet to one of the fastest-growing areas of IT investment, that it's difficult to put a finger on when the change happened. Was it when a group of cloud computing linked stocks - Facebook, Amazon, Netflix and Google - started to become known as the ‘FANG' stocks, to make it easier to talk about their collective performance? Or was it when mobile phones started asking you if you would like your photos to be automatically stored in the cloud to save memory space?
Now cloud computing appears to be everywhere - a natural outgrowth of the broadening and deepening of the capacity of the internet. The screen you look at is no longer dependent on the computer it is attached to, it is only constrained by the speed of your internet connection in terms of computing power and the memory storage it can access. That trend looks like it is only going to accelerate. The 5G networks being rolled out now globally are designed to bring mobile data speeds up to the same levels as those of high-speed residential broadband. In 2020, market intelligence firm IDC estimates that over half of all IT spending will be on cloud computing projects.
Investors tend to focus on those new or unique services and businesses - like the Facebook, Amazon, Netflix and Google grouping - that couldn't exist without cloud computing. However, it is worth bearing in mind that the potential for increased business productivity from the delivery of on-demand computing services is possibly even more revolutionary.
There are two important questions to consider when thinking about investing in a theme like cloud computing. The first is about the timing - not just is it too early or too late, but more importantly, how sustained is this change likely to be? Is this a fad, or is it a fundamental shift that will have repercussions and, therefore, provide potential investment opportunities beyond the immediate horizon? The second is: how do you invest in such a change?
To illustrate a potential answer, let's look at investing in a different theme: the development of the internet over the last 20 years as an example. Of course, past returns are no guide for future results. The table below shows investment returns from a number of indices over the last 20 and the last 10 years.
Source: Bloomberg, as at 31 December 2018. The data above is based on monthly data. Past performance is not a reliable indicator of future results.
As a baseline, the MSCI All Countries World index, produced a decent return of around 5% per annum over the past 20 years. The dotcom boom originated in the US, so we should expect that the US stock market would outperform that index, as it did. But the IT sector of the US barely outperformed the wider market over the same period; instead, the consumer-discretionary sector outperformed, which may seem strange as its main constituents used to be retailers and car manufacturers, but it also happened to include Amazon and Netflix.
The internet itself is such a powerful thematic idea. Over the last twenty years, the Dow Jones Internet Composite index has performed very well and even outperformed world and US equities stock markets. But the outperformance was even more dramatic in the second decade after the internet came to prominence (as seen above), highlighting how long term some themes can be and how long it may take for all the necessary investment to be made in order to achieve the desired results.
Of course, an investor could analyse these themes themselves and invest in the individual companies. However, the problem with that strategy is that these themes break established sectorial boundaries and are not restricted to any one country, so it would be a complex undertaking to keep abreast of how the theme developed and where the profits are being captured. A thematic index establishes a set of rules to include a range of companies that generate revenues from cloud computing. The ISE Cloud Computing Index tracks a group of 30 stocks that are involved in cloud computing. Not all of these companies are focused solely on cloud computing, but the composition of the Index dilutes the impact of an individual company's other activities so that the major driver of the performance of the index is likely to be the growth of cloud computing. First Trust has launched a pure-play US domiciled and Ucits ETF that tracks this index.
Gregg Guerin is senior product specialist at First Trust Global Portfolios