Investing in the internet using exchange traded funds

Internet companies – Amazon, Google, Apple – are among the hottest sector buys, and have been during the past five years, but it can be confusing, time consuming and costly picking the individual stocks for your portfolio.

Can a single purchase cover all the exposure you need for this sector?

Here we examine the technology sectors and the exchange traded funds that cover areas of this business segment.

We'll look at recent performance of the sectors and the ETFs as a guide to how investment coverage of technology and internet stocks can be simplified.

Internet and tech businesses

First, let's subdivide the sector between those stocks that are consumer facing – the Amazons, eBays and Netflix – and those that provide the services that support them – the Googles and Microsofts. 

Add to these the companies that fulfil several roles – like Apple, which not only provides online shopping services and web hosting, but also designs and produces the software and hardware they work on.

Amazon distribution centre: The online shopping website features in many internet ETFs - Source: Wikimedia Commons

The possibilities offered can present a confusing mix of stocks that don't necessarily move in tandem, yet belong together in coverage of the sector.

Top performing S&P 500 sectors

Looking at the 10 industry sectors on the S&P 500 index in the US over the past year, the stand-out performer has been the technology sector – up 30%, nearly double the rise of the overall index.

The best performing stocks within this sector are chipmakers, but high up there are Apple, eBay, Electronic Arts, PayPal, MicroSoft and Yahoo, all with annual gains of more than 36%.

Over a five-year timeframe, the sector has gained about 110% and roughly equals the performance of healthcare and financials.

In the five years, among the best performers in the tech sector have been Electronic Arts, up 773%; Facebook, up 454% and Alphabet (Google), up 248%.

The only sector above these during five years has been consumer discretionary – up 120%. Included in this sector are the likes of Netflix, up 1,737% and Amazon, up 383%.

Valuations

Given some of these meteoric gains in share price, one could expect some lofty valuations in the sector.

David Jane, manager of Miton’s multi-asset fund range, says: "Equity valuations are high, and in certain areas, extremely high, particularly for internet companies."

Does this mean investors should be wary of a correction in the sector?

The core stocks: ETFs pick about 40 core stocks which have a smoothing impact on the portfolio - Source: Pixabay

Let's take Apple as an example:

A correction is when the price of an asset or index falls by at least 10% from its most recent peak. A fall of more than 20% is typically indicative of a bear market.

Apple has experienced at least five corrections over this five-year period. Four of these developed into bear markets – the first, a prolonged seven-month decline, beginning in September 2012, in which the stock lost three-quarters of its value.

Despite this, the stock is up 94% over the five years – a fine return if you had the nerve to hold on to it during the slumps.

Indeed, Jane says: "We should be prepared for a near term correction following an extended period of continuous rises."

He adds: "We have to accept that they are a feature of equity markets at all times. These small bumps are an accepted part of investing for the long term."

Why invest in ETFs

ETFs pool cash from many thousands of investors which is then used to buy a series of stocks or assets, depending upon certain themes and strategies.

The resulting basket of assets is then capitalised as a single stock and issued to investors as shares that can be freely traded on a stock exchange.

There are several good reasons to invest in ETFs.

As already noted, it is cheaper and more simple to buy an ETF than accumulate all the stocks you might need to fulfil your trading strategy.

Should you not be happy with the performance of your ETF, it is quicker, easier and less costly to liquidate than a portfolio of stocks.

And furthermore, because ETFs are traded on stock exchanges, many are also available on retail trading platforms.

Finally, ETFs tend to be less volatile than individual assets as their multi-asset composition has a smoothing impact on price movement.

Internet ETFs: There are many trading themes to choose from, including index trackers and EM funds - Source: Pixabay

Internet ETFs

Depending on your strategy, there are many internet ETFs to choose from. Among them are index trackers and emerging market-focused ETFs.

For the purpose of this exercise, however, we will look into three of them:

1. The largest - First Trust Dow Jones Internet Index Fund (FDN)

2. The best performing (in the last year) - ARK Web x.o ETF (ARKW)

3. The best performing EM - Emerging Markets Internet & eCommerce ETF (EMQQ)

First Trust Dow Jones Internet Index Fund

Launched in June 2006, this is by far the largest, with $4.5bn in assets under management, and has returned 20.6% so far this year (to 6 June, 2017).

It is a wholly US-focused fund comprising 42 constituents, but is reviewed on a quarterly basis. Those that drop out of the top 40 US internet companies in terms of valuation are reviewed for replacement by new entrants.

Each constituent is given a weighting – currently the top five weightings are as follows:

1. Amazon – 8.94%

2. Facebook – 8.26%

3. Netflix – 5.43%

4. Alphabet (Google) – 5.29%

5. PayPal – 5.25%

ARK Web x.o ETF

Less than three years old, this ETF has $46.6m in assets under management, but its return of 44.2% so far this year makes it the best performing fund in the internet sector.

It comprises global internet companies, most from the US, but also from Japan and China, among others.

Here are the top five weightings:

1. Athenahealth – US cloud-based medical services – 7.54%

2. Amazon – 7.52%

3. 2U – US cloud-based education services – 5.26%

4. Tesla – US motor/energy storage – 4.29%

5. NVIDIA – US video graphics – 3.91%

Emerging Markets Internet & eCommerce ETF

This fund is also less than three years old – founded in November 2014. It has $100.7m in assets under management and has returned 42.9% so far in 2017.

It comprises 40 mainly Asian emerging market assets. Here are the top five weightings:

1. Tencent – Shenzhen-based internet company – 8.37%

2. Alibaba – China's biggest ecommerce and payment services company – 7.52%

3. Naspers – South African internet company – 7.48%

4. Mercadolibre – Argentine online marketplace – 5.97%

5. CTrip.com – Chinese online booking services – 5.65%

Further research available

These are just three of the top ETFs – mainly to be bought and sold through brokers as they are actively managed and charge fees.

Many others are available – some can even be traded commission free on online retail platforms – you can research simply enough online.

But remember – look for liquidity. Make sure the ETF is big enough and trading volumes are broad enough to ensure you can buy and sell as quickly as possible.

Remember your strategy is internet companies and so remember the inherent risks when investing in this sector.

By its very nature, business is fast paced, technologies are ever changing and obsolescence – even for companies that are currently riding high – can be just around the corner.