Software ETFs Surge: A Deep Dive Into the Best Performers of 2018

The technology sector’s remarkable growth this year has been largely driven by one segment: software. The data tells a compelling story. The S&P North American Technology-Software Index has delivered impressive returns of 28% year-to-date, substantially outperforming the broader Technology Select Sector SPDR (XLK), which has gained 14%. This divergence underscores a fundamental truth—not all tech investments are created equal.

Why Software ETFs Are Leading the Charge

Several tailwinds are propelling software ETFs forward. Cloud infrastructure, cybersecurity platforms, customer relationship management systems, internet-based applications, and the gaming sector have all witnessed robust demand forecasts. Corporate spending is the primary catalyst; according to State Street’s analysis, global enterprise software expenditures are projected to expand by 6.2% in 2018, marking the highest growth trajectory since 2007.

This confluence of factors has made software ETFs an attractive vehicle for investors seeking exposure to technology’s most resilient segment.

Core Players: Mega-Cap Dominated Funds

iShares North American Tech-Software ETF (IGV) stands as one of the sector’s most established vehicles, commanding $2.08 billion in assets under management. The fund maintains a 0.48% expense ratio and tracks the S&P North American Technology-Software Index on a market-cap-weighted basis. This concentration approach means just four holdings—Salesforce.com (CRM), Microsoft (MSFT), Adobe Systems (ADBE), and Oracle (ORCL)—account for over one-third of portfolio weight. The payoff has been undeniable: a 28% year-to-date return. However, prospective investors should note the fund’s elevated valuation metrics, with a price-to-earnings ratio exceeding 46, suggesting premium pricing relative to broader technology funds.

Alternative Weighting: Breaking Free From Mega-Caps

For those seeking diversification beyond the industry’s largest names, SPDR S&P Software & Services ETF (XSW) offers a compelling alternative. Operating as an equal-weight fund with 127 holdings, XSW ensures no single position commands more than 1% of assets. The top 10 holdings collectively represent just 9.2% of fund weight. This structural approach has yielded a 25% year-to-date advance while maintaining a more moderate P/E ratio of 25.30. At just 0.35% in annual fees, XSW also provides cost efficiency.

Factor-Based Approaches

Invesco Dynamic Software ETF (PSJ) employs a fundamentally different methodology, following the Dynamic Software Intellidex Index. This approach evaluates companies across price momentum, earnings momentum, quality metrics, management action, and valuation factors, resulting in a tightly curated portfolio of 30 holdings. The outcome: a 29% year-to-date return with Microsoft and Salesforce contributing approximately 10.5% of portfolio weight. Despite allocating over 81% to growth-oriented equities, PSJ has maintained volatility levels only marginally higher than the Nasdaq-100 Index over the past three years.

Emerging Thematic Opportunities

Beyond traditional software plays, specialized software ETFs have emerged to capture secular growth trends.

ETFMG Prime Cyber Security ETF (HACK) captures the cybersecurity ecosystem, which extends beyond pure software to include hardware, consulting, and managed services. More than 62% of HACK’s composition consists of software companies. The rationale is compelling: cybersecurity incidents inflicted $3 trillion in damages just three years ago, with projections suggesting this figure could double to $6 trillion by 2021. This trajectory will drive substantial capital allocation toward defensive technologies.

ETFMG Video Game Tech ETF (GAMR) operates at the intersection of gaming and software innovation. Though hardware considerations exist, GAMR functions as a credible software vehicle, with overlap to traditional software ETF holdings including Electronic Arts (EA). The fund’s performance speaks volumes—a more-than-doubling of value over the past three years. The digital distribution revolution provides ongoing momentum: digitally downloaded games comprised just 31% of sales in 2010, expanded to 74% by 2016, and are forecast to reach 93% by 2021.

Next-Generation Themes

Global X Future Analytics Tech ETF (AIQ) represents the newest breed of software ETFs, debuting in May 2018. Tracking artificial intelligence and big data indices, AIQ operates across an 83-company portfolio with more than 51% classified as software entities. The fund has attracted substantial seed capital, currently managing approximately $53 million in assets with a 0.68% expense ratio.

First Trust Cloud Computing ETF (SKYY) positions investors in the cloud computing revolution, capturing both traditional and internet software purveyors, which collectively represent over 54% of fund exposure. With a 0.6% annual fee, SKYY offers economical access to this structural shift. The market backdrop supports this thesis: worldwide public cloud services are projected to expand 21.4% in 2018 to $186.4 billion, climbing from $153.5 billion in 2017.

The Verdict

Software ETFs have demonstrated their capacity to outperform broader technology benchmarks by capturing secular industry dynamics. Whether through mega-cap concentration, equal-weight diversification, momentum-based selection, or thematic specialization, investors now possess multiple avenues to participate in software’s continued resilience within the technology sector.