Seven Leading Software ETFs Worth Adding to Your Portfolio in 2018

If you’re seeking exposure to the technology sector’s strongest performers, software ETFs deserve your attention. In 2018, software emerged as the clear driver of technology sector gains, with the S&P North American Technology-Software Index surging 28% year-to-date, significantly outpacing the broader Technology Select Sector SPDR (XLK) at 14%. This performance differential highlights why software ETFs have captured investor interest across multiple market segments.

The compelling case for these funds rests on robust revenue expectations across diverse software platforms including cloud services, cybersecurity, customer relationship management, internet applications, and video games. Before diving into specific products, it’s important to understand how different software ETFs employ varying strategies to capture this growth, each suited to different investor preferences and risk tolerances.

Traditional Market-Cap Weighted Software ETFs

For investors seeking exposure to the industry’s established leaders, the iShares North American Tech-Software ETF (IGV) represents one of the largest and most established software ETFs in the market. With $2.08 billion in assets under management, IGV tracks the S&P North American Technology-Software Index using market-capitalization weighting. This means the fund heavily concentrates in the industry’s giants—just four companies (Salesforce.com, Microsoft, Adobe Systems, and Oracle) comprise over one-third of the fund’s portfolio.

The benefit of this concentration is significant: IGV delivered a 28% year-to-date return. However, investors should recognize the trade-off. The fund’s price-to-earnings ratio exceeds 46, reflecting a substantial valuation premium compared to broader technology funds. This expense ratio of 0.48% annually ($48 per $10,000 invested) remains reasonable for a fund of this scale and reputation.

Equal-Weight Strategy: Diversified Software ETFs

Not all software ETFs emphasize mega-cap dominance. The SPDR S&P Software & Services ETF (XSW) takes an equal-weight approach, holding 127 positions where no single holding exceeds 1% of portfolio weight. The fund’s top 10 holdings combine for just 9.2% of assets. This construction rewards exposure to mid-sized and smaller software companies that demonstrated particular strength in the period, generating nearly 25% year-to-date gains.

With a lower expense ratio of 0.35% and a more attractive P/E ratio of 25.30 compared to IGV, XSW offers differentiation for investors uncomfortable with the valuation premium of market-cap weighted alternatives. According to State Street’s recent analysis, global corporate spending on software and services is projected to increase 6.2% in 2018—the highest annual growth rate forecasted since 2007—supporting this broader-based approach.

Active Strategy: Momentum and Quality Screening

The Invesco Dynamic Software ETF (PSJ) employs a fundamentals-based indexing approach through the Dynamic Software Intellidex Index. Rather than market-cap or equal-weighting, PSJ evaluates companies across multiple criteria including price momentum, earnings momentum, quality, management action, and value metrics. This selection process generates a concentrated roster of just 30 holdings.

The concentrated approach paid off, with PSJ returning over 29% year-to-date, driven partly by significant positions in Microsoft and Salesforce (combining for 10.5% of weight). Despite allocating over 81% of assets to growth stocks, PSJ maintained annualized volatility only slightly higher than the Nasdaq-100 Index over the past three years, demonstrating that active screening can improve risk-adjusted returns within software ETFs.

Specialized Sector Focus: Cybersecurity and Emerging Tech

Beyond traditional software ETFs, investors can gain targeted exposure through specialized funds. The ETFMG Prime Cyber Security ETF (HACK) captures the cybersecurity theme, with over 62% of holdings in software companies. The Prime Cyber Defense Index includes companies offering hardware, software, consulting, and services to defend against cybercrime. This focus gains relevance as estimated damages from cybersecurity attacks jumped from $3 trillion just three years prior to projected $6 trillion by 2021—a trend driving substantial corporate and government spending on security solutions.

The ETFMG Video Game Tech ETF (GAMR) represents another specialized approach, with significant overlap to traditional software ETFs through holdings like Electronic Arts. Despite hardware industry connections, GAMR qualifies as a credible software investment vehicle, having more than doubled over three years. The fund benefits from digitalization trends in gaming, with digitally downloaded games rising from 31% market penetration in 2010 to 74% in 2016, expected to reach 93% by 2021.

Innovation-Focused Strategies: AI and Cloud Computing

The Global X Future Analytics Tech ETF (AIQ), launched in May 2018, targets the artificial intelligence and big data intersection through the Indxx Artificial Intelligence & Big Data Index. Though not a pure software fund, AIQ counts Microsoft and Adobe among top holdings shared with traditional software ETFs, with over 51% of its 83 holdings classified as software companies. Launched with substantial seed capital, AIQ accumulated approximately $53 million in assets by September, gaining 5.1% within its first 2.5 months.

The First Trust Cloud Computing ETF (SKYY) captures cloud infrastructure and software trends. With over 54% exposure to traditional and internet software purveyors, SKYY participated in the cloud computing boom driving Microsoft’s 30% annual gains. The broader cloud services market is projected to grow 21.4% in 2018 to reach $186.4 billion, up from $153.5 billion in 2017 according to Gartner Inc., providing structural support for cloud-focused software ETFs.

Choosing Among Software ETFs: Strategic Considerations

The choice between these software ETFs depends on your investment philosophy and risk tolerance. Market-cap weighted software ETFs like IGV offer large-cap stability but command valuation premiums. Equal-weight alternatives like XSW provide broader diversification and lower valuations. Active selection strategies through PSJ target quality and momentum characteristics. Specialized funds address specific software trends like cybersecurity, gaming, AI, and cloud computing.

Expense ratios range from 0.35% (XSW) to 0.75% (GAMR), with most clustering around 0.6%, representing reasonable costs for specialized sector exposure. The 2018 performance differential between the S&P North American Technology-Software Index and broader technology indices demonstrates that software ETFs can meaningfully enhance technology sector returns when the industry’s fundamentals support growth. For investors convinced software’s leadership position will persist, 2018 represents the third consecutive year in four that software-focused vehicles have outpaced the broader sector, suggesting these specialized funds merit serious consideration.