The technology sector plays a catalyst role in economic growth. During the 2020 pandemic, it’s particularly felt. If you compare the performances of various sectors, it’s the technology that tops the list with 22.35% YTD growth. While the world is experiencing probably the worst economic crisis of the decade, NASDAQ is making new all-time highs.
Technology sector companies employ technological breakthroughs related to information technology to develop and produce goods and services. The sector impacts many other industries increasing their efficiency. It has also become a part of our day-to-day lives by providing us with highly-technological personal devices such as computers, mobile devices, home appliances etc. Businesses benefit from enterprise software, cybersecurity, corporate cloud services etc.
The technology sector is exceptionally diverse and ever-evolving, and it’s hard to break it down into constant subsectors.
Generally, we can define several broad technology groups:
- Networking and Internet
Some of the fastest-growing trends are cloud services, artificial intelligence, cybersecurity, edge computing, blockchain etc. The industries’ professionals would argue whether some of those trends belong to the groups above. As the technology sector is complex, for the sake of the overall clarity in the booming technology world, it’s reasonable to use such generalizations.
Just as there is a variety of tech companies, their business models are diverse as well. Some focus on retail sales margins. Others are advertising and subscription-based. Let’s see what the primary income streams of the biggest tech companies are.
Safer investing in the Technology sector with ETFs
Technology overall is a volatile sector. The reason is that there are constant swings of innovations technologies get popular and then can suddenly go out of fashion (consider 3D movies, for instance). One of the biggest advantages of investing in ETF is the protection of unfortunate events that happen on to individual companies in the area you target. You can have the right vision about the sector or a trend, but just because of some accidents in a company, the stock can sink on the momentary negative sentiments of other investors. That’s where ETFs come in place – you can mitigate those kinds of risks.
Follow Technology trends with ETFs
For the long-term investments, the technologies for businesses have more attractive prospective compared to consumer technology. The reasons for that are related to predictable product cycles, lower government policy risks, and barriers to joining the industry.
The most significant trend that boosts the efficiency of businesses is Cloud computing. Enterprises can now cut costs on their corporate computer networks, servers, and data storage. Cloud services market penetration is growing 20 to 25 percent annually. First Trust Cloud Computing ETF (NYSE: SKYY) enables us to invest in this area of technology.
Another vivid trend observed – the software is valued more than hardware. As software, in general, requires lower production costs and scalable easier, investors expect higher rates of growth of the industry. SPDR S&P Software & Services ETF (NYSE: XSW) can get you exposed to software and services companies.
Technologies get more and more integrated with our daily lives. The trend is known as the “Internet of things” promotes the devices and sensors coordinated by the internet. It’s projected that the number of devices will increase from 30 billion today to 500 billion by the end of the decade. If you want to bet on this trend, Global X Internet of Things ETF (NYSE: SNSR) is available to invest in.
The Biggest Technology Sector ETFs
In the financial markets, everything is often relative. When we talk about growth, we should look into the bigger picture, how that growth looks like in comparison with the benchmark assets. The biggest ETFs by their assets under management can serve that purpose as the most common vehicle to get exposure to the sector. Let’s look at the top ETFs by AUM in the table down below.
Total assets ($MM)
Invesco QQQ (NYSE: QQQ)
Vanguard Information Technology ETF (NYSE: VGT)
Technology Select Sector SPDR Fund (NYSE: XLK)
All of the top three ETFs are heavily invested in tech giants like Apple Inc and Microsoft Corp with the only difference that QQQ includes Amazon.com Inc to the top three of its holdings while VGT and XLK hold Visa Inc instead.
QQQ focuses on Large-Caps providing exposure to the popular NASDAQ equity benchmark. The large average daily volume makes QQQ stand out as an active trading vehicle, including intraday trading. The ETF is quite volatile. Thus it’s less likely to be used for a balanced portfolio approach. The top holdings are Apple Inc – 12.26%, Microsoft Corp – 11.42%, and Amazon.com Inc 10.87%.
VGT exposes an investor to the following sub-industries: software, hardware, and consulting. The fund is less volatile due to its holdings that are mostly large-caps. The fund is more suitable for value investors, though it doesn’t cover all industries of the technology sector. Here are the top three holdings of the fund: Apple Inc – 20.32%, Microsoft Corp – 17.85% and Visa Inc – 3.98%.
XLK is the fund that has holdings in the broad range of sub-industries, manly focused on large-caps. Technology and communication services stocks take the biggest part of the fund’s allocation. One of the advantages of the ETF is that it doesn’t exclude any industry of technology sector for capital allocation. The top three holdings are similar to VGT: Apple Inc – 21.98%, Microsoft Corp – 21.78%, Visa Inc – 4.58%.
How to trade and how to invest in Technology ETFs
In general, technology is not the best sector for investors seeking dividend incomes, the sector’s average yield is just 1%. Due to the nature of the sector, tech companies are focused on reinvesting profits in innovations that would spur their future growth. If you still aim for dividend returns from the technology sector, you should look into mature companies that have developed their client base and have the records of consistent returns. The ETFs with holdings like IBM, Cisco, Intel etc. will be suitable.
Investors and traders that aim for capital appreciation don’t need to focus solely on the companies that are profitable now. Usually, it takes some time for new tech companies to gain consistent profits as they develop infrastructure and the client base for their market. Investing in techs, in the beginning, offers the highest reward potential.
Seeking the highest move potential in technology, we can look into the ETFs that are comprised of new, innovative companies. They are not necessarily profitable at the moment, but the nature of their business is aligned with the current trends. The ETFs such as ARK Innovation ETF (NYSE: ARKK) and ARK Next Generation Internet ETF (NYSE: ARKW) offer higher growth potential performing currently 59.36% and 62.65% YTD respectively versus broad tech ETF Invesco QQQ Trust which gained 22.35% YTD.
Look at the comparison of the performance of ARKK and ARKW versus the benchmark QQQ on the chart below. The red line is ARKK, and the orange one is ARKW. Notice, however, that ARKK and ARKW underperformed at the times of distress around the bottom of the decline in March (see a smaller grey area), but as the recovery settled down, the innovators gained the confidence to outperform QQQ (a big grey area).
The technology sector encompasses many diverse sub-industries. Companies vary in their business models while generally shifting to subscription-based, especially software. Some of the prevalent trends in technology are automation and AI, cloud computing, the Internet of Things, etc. It pays off better if we specialize and focus on a specific sub-industry when investing in technology. ETFs provide a simple way to get exposure to sub-industries and invest in tech trends. Depending on your investment objectives, you would consider different industries. Investors seeking dividend incomes can use ETFs comprised of mature companies, while the risk-takers looking for the highest growth potential should focus on the ETFs holding new, innovative companies that emerged as the result of the trends in the sector. The current pandemic situation catalyzes tech companies to penetrate the market further as people need to use the internet for work and study far more often.