A Super Software ETF For Q3

The technology sector is again leading the broader market higher and software stocks are significant contributors to that theme. The S&P North American Technology-Software Index, for example, is up more than 27 percent year-to-date.

Cap-weighted software benchmarks and exchange traded funds are widely followed, but some alternative strategies bear monitoring in the third quarter, including the SPDR S&P Software & Services ETF XSW.

What Happened

The equal-weight XSW follows the S&P Software & Services Select Industry Index. That benchmark offers “exposure to the software and services segment of the S&P TMI, which comprises the following sub-industries: Application Software, Data Processing & Outsourced Services, Home Entertainment Software, IT Consulting & Other Services, and Systems Software,” according to XSW's issuer.

As an equal-weight ETF, XSW tilts toward smaller stocks. The weighted average market capitalization of the fund's 127 holdings is $26.72 billion, which is slightly below the mean market value of $27.53 billion on the S&P North American Technology-Software Index.

Why It's Important

XSW is up more than 25 percent year-to-date and currently resides near all-time highs, but the ETF has the potential for more near-term upside.

“With growth becoming challenging, investors may want to tilt toward sectors and industries with high growth potential and consistently beating earnings expectations,” said State Street Global Advisors (SSgA) in a recent note. “In later stages of the business cycle, higher wage pressure and increasing capacity utilization has created incentive for companies to automate with technology and increase productivity with software systems.”

Application software makers represent about 36 percent of XSW's portfolio with data processors and systems software firms combining for about 46 percent.

What's Next

Robust software could trigger more upside for XSW in the second half of 2018.

“Thanks to strong demand for enterprise software, global corporate spending on software and services is projected to increase by 6.2% in 2018, the highest annual growth rate forecasted since 2007,” said SSgA.

Data suggest investors are displaying enthusiasm for XSW this year. While the ETF has just $103.70 million in assets under management, nearly $33 million of that sum has flowed into the fund just this year.

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