UK investors have become increasingly familiar with the ‘cloud’, and not just because Brits like talking about the weather. The emergence of cloud computing has been one of the most successful investment themes over the past decade, but its growth has years to run, with Fortune Business Insights forecasting that global cloud revenues will top $760 billion by 2027. That’s about the size of Turkey’s GDP last year, based on World Bank figures.

This stunning growth trajectory implies annual average compound growth of 18.6% a year between 2020 and 2027, according to the Cloud Computing Market Size report put together by Fortune. The study estimated global cloud revenues were approximately $199 billion in 2019.

The cloud has helped drive the astonishing success of some of the world’s biggest companies. Amazon, Alphabet’s Google and Microsoft have built trillion dollar-plus market valuations on the back of the cloud.

Apple’s gradual shift from hardware to software services and apps is one of the major reasons why investors have rallied behind the story in increasing numbers throughout 2020 despite the Covid outbreak, earning the business a price tag worth more than $2 trillion, making it the world’s most valuable listed business.

Yet as the eye-popping forecasts indicate, we ain’t seen nothing yet. ‘Cloud is as hot a topic as ever, but the move by companies onto the cloud, in our view, is only the beginning of the digital revolution,’ says Indraneel Arampatta, an analyst at technology website Megabuyte.

The Covid pandemic, various lockdown measures and the swathe of organisations that have been forced to work from home have simply accelerated a shift that was already happening. Working from home naturally leans heavily on the cloud, with professional-level communications, including text, video and voice calls, needed as well as remote access to critical applications.

But this is not just an opportunity for technology enthusiasts; the cloud is touching massive swathes of our economy and society, affecting how we use financial services and many of the basics for our everyday lives.

Retail is being turned on its head by the cloud-powered internet, and we are beginning to see similar transformations happening across other sectors, such as healthcare, manufacturing, energy, education, media and entertainment, as well as how we interact with public services provided by local and central government.

A world of cloud acronyms

As with many new ideas these days, investors are often asked to familiarise themselves with pet names, acronyms and jargon, and cloud has its share. The main ones to understand are SaaS, PaaS and IaaS, or software-as-a-service, platform-as-a-service and infrastructure-as-a-service.

This is sometimes referred to as the cloud computing ‘stack’ because they build on top of one another. Knowing what they are and how they’re different makes it easier for investors to understand the industry and the stocks they might want to invest in.

Infrastructure-as-a-service (IAAS)

This is the most basic category of cloud computing services. With IaaS, you rent IT infrastructure – servers and virtual machines, storage, networks, operating systems – from a cloud provider on a pay-as-you-go basis. This is where Amazon, Microsoft and Alphabet currently dominate.

Platform-as-a-service (PAAS)

PaaS is a computing service that supplies an on-demand environment for developing, testing, delivering and managing software applications. PaaS is designed to make it easier for developers to quickly create web or mobile apps, without worrying about setting up or managing the underlying infrastructure of servers, storage, network and databases needed for development.

Integrated communications company Twilio is a good example of PaaS, and many industrial business applications suppliers, including engineering software suppliers such as Aveva (AVV), Autodesk and Adobe, run PaaS operations for clients, while you could consider Facebook as a PaaS company for advertisers.

Software-as-a-service (SAAS)

Software-as-a-service is a method for delivering software applications over the internet, on demand and typically on a subscription basis. With SaaS, cloud providers host and manage the software application and underlying infrastructure, and handle any maintenance, such as software upgrades and security patching. Users connect to the application over the internet, usually with a web browser on their phone, tablet, PC or other connected device. Netflix and Spotify are good examples of SaaS businesses.

Source: Microsoft, Shares

WHAT IS THE CLOUD?

Cloud computing is the delivery of computing services – including servers, storage, databases, networking, software, analytics and intelligence – over the internet to offer faster innovation, flexible resources and economies of scale.

Cloud computing eliminates the capital expense for a company of buying hardware and software, and setting up and running on-site data centres – the racks of servers, the round-the-clock electricity for power and cooling and the IT experts for managing the infrastructure.

The benefits of cloud computing services include the ability to deliver the right amount of IT resources when they’re needed, and from the right geographic location.

‘Public and private cloud platforms are the key to storing and sharing the massive amounts of data required to feed AI processes, and to delivering the standardisation required for artificial intelligence automation,’ says ROBO Global.

‘The biggest cloud computing services run on a worldwide network of secure data centres, which are regularly upgraded to the latest generation of fast and efficient computing hardware. This offers several benefits over a single corporate data centre, including reduced network latency for applications and greater economies of scale,’ says Microsoft.

‘By increasing the speed of innovation, rapidly delivering new services, and supporting the latest advancements in AI, cloud providers help companies accelerate the delivery lifecycle and rapidly evolve and improve products and services,’ comments ROBO Global.

Most cloud computing services are provided as self service and on demand, so even vast amounts of computing resources can be provisioned in minutes, typically with just a few mouse clicks, giving businesses a lot of flexibility and taking the pressure off capacity planning.

On-site data centres typically require a lot of ‘racking and stacking’, or in other words, hardware set-up, software patching and other time-consuming IT management chores. Cloud computing removes the need for many of these tasks, so IT teams can spend time on achieving more important business goals.

Data back-up, disaster recovery and business continuity is easier to manage and less expensive because of cloud computing. This is because data can be mirrored at multiple redundant sites on the cloud provider’s network.

HOW TO INVEST IN CLOUD-RELATED BUSINESSES

Gary Robinson, co-manager of Baillie Gifford American (0606196) and Baillie Gifford US Growth Trust (USA), up 83% and 73% respectively this year, says investors underestimate growth potential of cloud enablers like Amazon and Alphabet.

Recent investments by the manager were based on the idea of more companies going online, where he expects the pandemic to spur an acceleration of existing trends after office life started to look like a ‘relic’.

The manager added to workplace collaboration and communications app Slack, which was first held as a private company in the US Growth trust, and last year bought into video conferencing provider Zoom.

‘There’s going to have to be better tools to allow people to coordinate in companies that are working with more freedom with their workforces,’ says Robinson.

Slack’s approach of channels-based communication centres around a project or topic rather than an individual inbox, making it more suited for collaboration, the manager argues. ‘Email just doesn’t work. It’s not a good tool for collaboration at all.’

Cloud software company Workday is another stock to join his portfolios. According to Robinson it has already captured more than half of the market share in human resources software used by Fortune 500 companies. What particularly excites him, however, is its move into other areas of business software, particularly for financial systems, such as accounting.

The manager says Workday is starting to see an inflection in demand in this area, as more companies look to replace legacy IT systems in the face of cloud-based applications. Shopify, Amazon and The Trade Desk are other investments in Robinson’s portfolios.

TWO PASSIVE FUNDS TO BUY

Some of the stocks relevant to cloud theme are highlighted in the accompanying box. If you would prefer to invest in a fund, the First Trust Cloud Computing ETF (FSKY) is a good place to start. It tracks 50 of the world’s leading cloud stocks, including many of the companies mentioned in this feature.

It provides wider cloud growth opportunities while still handing investors stock diversification. With an ongoing charge of 0.6%, the fund may seem expensive for an ETF, although it would still be cheaper than many actively managed funds. For example, if you invested £10,000 over five years and achieved 5% return a year, an investor would pay total fees of £336.79, according to AJ Bell calculations, on an investment that would be worth £12,383.82 after those fees were paid.

Investors could also consider L&G ROBO Global Robotics and Automation (ROBO). Cloud computing and AI is one of the fund’s 12 core investment themes and stocks are drawn from across the world and from both large and small cap sub-sectors. It has a 0.8% total expense ratio.

THREE ACTIVE FUNDS TO BUY

Baillie Gifford American (0606196)

This fund has beaten its benchmark comfortably over three, five and 10 years and the management team have years of experience and proven expertise. This is a great option for investors and provides access to one of the most respected fund management firms around today. Ongoing charges are 0.51%.

Relevant companies in the portfolio: Shopify, Amazon, The Trade Desk, Netflix

Polar Capital Global Technology (B42W4J8)

Managed by the tech savvy duo of Ben Rogoff and Nick Evans, similarly to the Baillie Gifford fund, this is very much about creating value from owning some of the world’s most disruptive technology companies for the long-term. Cloud computing plays a large part in the managers’ thinking and investors will also get some of the most comprehensive market and sector updates around. Total expense ratio stands at 1.51%, which may put off some investors but it has a good track record.

Relevant companies in the portfolio: Microsoft, Tencent, Alibaba, Facebook

Blue Whale Growth (BD6PG78)

A relatively new fund just approaching its third anniversary, it has a concentrated portfolio of around 25 stocks which its team of analysts follow in great depth. The fund has returned 21.7% so far in 2020, which is no mean feat given the macro challenges, and it has outperformed its benchmark by about 12%. Ongoing costs run at 1.14%.

Relevant companies in the portfolio: Microsoft, Adobe, Autodesk, PayPal

Three types of cloud

Public cloud refers to a cloud service that shares resources with other users and is generally available over the internet. Basic email services, social media like Facebook and streaming service Netflix are common examples of offerings hosted on a public cloud service that many consumers use daily.

Private cloud isn’t shared. It’s usually a data centre located on a company’s property that provides services via a closed network rather than making them available via the public internet. Many non-tech companies such as banks want to have complete control over their data and IT, so as they embrace digital, internet-based operations and services they build on-site data centres to create a private cloud, using hardware from the likes of Cisco, Arista Networks, NVIDIA and others.

A hybrid cloud refers to a service that uses a mix of public and private clouds to function. For example, an organisation might make use of public networks to access and operate less critical data and operations but automatically switch over to its private network when the data reaches a certain level of sensitivity.

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