IGV iShares Expanded Tech Software Sector ETF

The software giant – Microsoft (MSFT) – is becoming an investors’ darling as depicted by the recent surge in its share price. In fact, Microsoft is leading the way in the broad tech space this year leaving behind its rivals Apple (AAPL), Google (GOOG), Yahoo (YHOO) and Amazon (AMZN).

Also, the broad tech sector sell-off since the start of this month on valuation and earnings concerns has had a little impact on the stock, suggesting that MSFT has the potential to continue its strong performance in the coming months (read: The Momentum Stock Crash Puts These ETFs in Focus).

Microsoft hit a fresh 14-year high early last week and gained in double digits over the past three months thanks to the arrival of the new CEO Satya Nadella in early February and the optimism over the launch of its Office suite for Apple iPad. The recent rally seems encouraging, especially considering the fact that MSFT dropped 40% during the 14-year tenure of the previous CEO Steve Ballmer.

Solid Growth Prospects

With Nadella taking charge as the new CEO, Microsoft appears to be turning around its business with many unfolded opportunities on the way. Nadella is making several changes that would push MSFT into the mobile and cloud computing world from the traditional software space. This has spread optimism on the company’s future growth story.

The company in the tail end of March released a touch version of Office for Apple’s tablet and plans to offer free Windows on phones, tablets and other consumer devices on sub 9-inch screens. These services would drive sales in the coming years.

Additionally, both the company’s hardware and software businesses are growing. The demand for Xbox videogame console, new Surface tablets and Windows Phone devices is rising rapidly in the hardware segment while Azure cloud services and new Office for iPads will continue to boost software sales going forward.

Further, Microsoft is on track to close its $7.2 billion acquisition of Nokia's mobile phone business this month. The deal would strengthen the competitive position and would add revenue streams and profit opportunities for Microsoft. For example, Microsoft’s gross margin on sale of one Nokia handset would increase from the current $10 to $40 (read: 3 Tech ETFs to Watch on Microsoft-Nokia Deal).

Moreover, many analysts are bullish on the company’s growth outlook and revised their target prices upward, suggesting that the company is on a solid growth trajectory with the new CEO. Microsoft currently has a decent Zacks Rank #3 (Hold), underscoring that it has potential for upside.

Given the bullish outlook and the impressive run up in MSFT share prices, we have highlighted three ETFs with heavy exposure to this software giant for investors seeking to bet on the stock with much lower risk (see: all the Technology ETFs here).

iShares Dow Jones US Technology ETF (IYW)

This ETF tracks the Dow Jones US Technology Index, giving investors exposure to 143 stocks. The fund has AUM of nearly $3.9 billion while charging 45 bps in fees and expenses. Volume is solid as it exchanges more than 377,000 shares a day.

Microsoft occupies the second position in the basket with 10.21% of assets. The portfolio is evenly split between technology hardware and equipment, and software and computer services segments. The fund added 11.8% over the past three months and has a Zacks ETF Rank of 3 or ‘Hold’ with a High risk outlook.

iShares S&P North American Technology-Software Index Fund (IGV)

This ETF provides exposure to the software segment of the broader U.S. technology space by tracking the S&P North American Technology-Software Index. The fund holds a small basket of 61 securities with Microsoft taking the second spot at 9.33% of total assets.  

The fund is quite popular with over $1.3 billion in AUM while volume is moderate as it exchanges nearly 110,000 shares a day. The product charges 48 bps in fees and expenses and was up about 9.10% in the trailing three months. IGV has a Zacks ETF Rank of 2 or ‘Buy’ rating with a High risk outlook (read: Buy These 2 Tech ETFs on NASDAQ Sell-Off).

Select Sector SPDR Technology ETF (XLK)

The most popular technology ETF on the market, XLK follows the Technology Select Sector Index. This fund manages about $12.6 billion in asset base and trades in heavy volume of roughly 7.6 million. The ETF charges 16 bps in fees per year from investors. In total, the fund holds about 73 securities in its basket.  

Of these firms, Microsoft takes the second spot, making up 8.67% of the assets. In terms of industrial exposure, the fund is widely spread across technology hardware storage & peripherals, software, IT services, Internet software & services and diversified telecom service that make up for double-digit allocation. XLK gained nearly 13.5% over the past three months and has a Zacks ETF Rank of 3 or ‘Hold’ with a Medium risk outlook.

The following table compares the performance of these three ETFs with that of Microsoft from a risk/return tradeoff point of view.

ETFs	Trailing 3-Months Returns (as of April 4)	1 Year Return (as of April 4)	Correlation With Microsoft's  Share Price	Risk (Annualized Standard Deviation)
IYW	11.79%	19.82%	0.84	10.06%
IGV	9.10%	25.90%	0.97	12.04%
XLK	13.45%	22.21%	0.95	9.03%
MSFT	11.18%	39.45%	N/A	26.48%

Bottom Line

While it is true that Microsoft has generated much higher returns over the one-year period than the ETFs, the exposure to only MSFT requires above par risk appetite given its higher volatility (annualized standard deviation is 26.48%).

In order to minimize this risk, investors could definitely look to the three ETFs that have a high correlation to MSFT’s share price. Out of the three, XLK with a correlation of 0.95 seems the best choice for investors seeking to ride the most of the recent surge in Microsoft given higher returns and lower risk (read: Top Ranked Technology ETF in Focus: QTEC).

The other two products – IYW and IGV – also require lower risk tolerance levels and provide diversified exposure to the tech segment. However, both have clearly benefited from the jump in Microsoft shares, and could continue to do well if this software giant remains a strong performer in the months ahead.

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