Is It Time to Invest in Software Stocks? 3 ETFs to Consider Now

As we enter the final quarter of 2024, the recently underperforming software industry is showing signs of a rebound, potentially offering a compelling investment opportunity. Large-cap growth stocks, particularly in the technology, communications, and consumer discretionary sectors, are making a comeback, with software companies “quietly starting to break out,” according to Roth MKM. 

A technical breakout by the group could have serious legs, given how bleak sentiment seems to be toward software stocks. After lagging behind their large-cap peers in the semiconductor and platform spaces, software has now become a crowded short, and institutional investors are at their least overweight position on software since Jefferies began tracking the data.

This technical resurgence comes at a time when the global software market is projected to reach a staggering $858.10 billion by 2028, growing at a compound annual growth rate (CAGR) of 5.27%. This growth is fueled by several factors, including digital transformation initiatives (contributing 4.1% to market growth) and the shift towards cloud-based software (driving the market forward by 6.1%).

For investors looking to capitalize on a comeback in the software space, without picking individual stock winners, exchange-traded funds (ETFs) can offer a diversified approach to gain exposure to the software sector. These funds offer a strategically tailored basket of software stocks, allowing investors to benefit from the industry's overall growth, while mitigating company-specific risks. 

Let’s explore three ETFs that merit consideration for those seeking to invest in the burgeoning software market.

#1. SPDR S&P Software & Services ETF (XSW)

The SPDR S&P Software & Services ETF (XSW), launched in September 2011, has carved a niche for itself by focusing on replicating the performance of the S&P Software & Services Select Industry Index. This strategy tracks about 144 equities from the S&P Application Software, Interactive Home Entertainment, IT Consulting & Other Services, and Systems Software sub-industries.

XSW has gained 11.2% on a year-to-date basis, underperforming the broader S&P 500 Index ($SPX). Over the past decade, the fund is up 268%.

The fund's assets under management (AUM) total approximately $382 million, indicating a moderate-sized fund with significant room for growth. 

XSW is equal-weighted, and its top 10 holdings account for roughly 8% of the fund. Top constituents include AppLovin (APP), Cipher Mining (CIFR), MicroStrategy (MSTR), Klaviyo (KVYO), and Rapid7 (RPD). 

With an expense ratio of 0.35%, XSW is competitively priced within its category, offering investors a cost-effective way to gain exposure to the software sector. 

XSW has an average daily volume of fewer than 10,000 shares, which points to lower liquidity - suggesting that investors should be patient on entries and exits, and wait for a favorable price.

#2. iShares Expanded Tech-Software Sector ETF (IGV)

The iShares Expanded Tech-Software Sector ETF (IGV) has been a formidable player in the ETF landscape since its inception in October 2007. Designed to track the performance of the S&P North American Expanded Technology Software Index, IGV provides broad exposure to software-related companies, focusing primarily on large-cap technology firms. 

IGV has managed a year-to-date increase of 13.8%, and very respectable 32% return over the past year. The fund boasts substantial assets under management, totaling $7.08 billion. 

The ETF's top holdings are dominated by industry giants such as Salesforce Inc (CRM) (9.24%), Oracle (ORCL) (8.76%), Microsoft (MSFT) (7.85%), ServiceNow (NOW) (7.02%), and Adobe (ADBE) (6.82%). The fund's top 10 holdings account for 57.5% of its weight, underscoring IGV's concentrated investment strategy in leading technology firms.

With an expense ratio of 0.40%, IGV remains competitive within its category, offering investors a cost-effective means to gain exposure to the software sector. 

Additionally, IGV offers robust liquidity, with an average daily share volume of approximately 3 million. This liquidity ensures ease of entry and exit for investors looking to capitalize on the dynamic growth potential within the software industry.

#3. Invesco AI and Next Gen Software ETF (IGPT)

The Invesco AI and Next Gen Software ETF (IGPT) has been making waves in the investment community since its inception in June 2005. This ETF is designed to track the STOXX World AC NexGen Software Development Index, focusing on companies that are significantly involved in next-generation software development technologies. By investing at least 90% of its assets in stocks that make up this index, IGPT aims to mirror the performance of these innovative tech firms closely. 

This strategy has paid off in 2024, with the fund posting a year-to-date gain of 19.4% and a 40.7% increase over the past year. The fund manages assets totaling approximately $395 million, indicating a moderate size with significant growth potential.

The ETF's top holdings include influential technology leaders such as Nvidia (NVDA) (8.75%), Meta Platforms (META) (8.29%), Alphabet (GOOG) (7.98%), Advanced Micro Devices (AMD) (7.82%), and Adobe (ADBE) (6.38%). These companies are at the forefront of technological innovation, combining software with hardware and AI innovations to drive the fund's impressive performance - and underscoring its focus on future-oriented software development.

IGPT's expense structure includes a management fee of 0.50% and a total expense ratio of 0.61%, which is relatively competitive within the ETF landscape.  

With an average daily trading volume of around 45,000 shares, IGPT offers reasonable liquidity for long-term investors looking to enter and exit positions, though traders should be disciplined about limit orders. 

Overall, the fund's focus on capital appreciation through strategic investments in leading tech firms makes it an attractive option for those looking to invest in the future of software development without selecting individual stocks.

Conclusion

In summary, investing in software stocks through ETFs like XSW, IGV, and IGPT offers a smart way to tap into the sector's growth without the hassle of picking individual winners. Each of these funds brings something unique to the table, whether it's a focus on pure-play software, large-cap stability, or cutting-edge tech innovation that adds AI to the mix. With the software industry poised for continued expansion, these ETFs provide a balanced and diversified approach for investors looking to ride the wave of technological advancement.

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