Investing in Internet companies is attractive considering their excellent growth potential. The use of the Internet is growing rapidly as it enables convenient, quick, and secure connectivity between consumers and suppliers. Internet usage is gaining traction not only in the developed countries but also in emerging economies like China, which now claims to have the largest base of Internet users.
Internet funds have performed well in the past two years. First Trust Internet ETF (NYSEARCA:FDN) has gained 145% - more than three times of the S&P 500’s 45% gain.
Although Internet funds are viewed as single sector funds, in reality they offer exposure to companies spanning a variety of sectors.
Internet companies fall in two broad categories, those that enable the Internet to generate profits and those that use the Internet to generate profits.
Internet enablers typically fall within the information technology sector. These include companies like Cisco Systems (NASDAQ:CSCO) and content delivery networks like Akamai Technologies (NASDAQ:AKAM).
Internet users often hail from other sectors like consumer discretionary, financial services, or health care. Examples of such companies include:
- Amazon.com (NASDAQ:AMZN), the largest online retailer selling goods from books to shoes
- Netflix (NASDAQ:NFLX), an online provider of movie rental subscription services
- priceline.com (NASDAQ:PCLN), a company offering travel-related services online
- TD AMERITRADE (NYSE:AMTD), an online securities brokerage and financial services firm
- WebMD Health (NASDAQ:WBMD), an online health care information provider for consumers and medical professionals.
Additionally, there are behemoths like Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) that enable the Internet with search capability they provide and connect customers to businesses through their advertisements networks.
There are three families offering exchange-traded entities for investing in the Internet: First Trust, Invesco PowerShares and Merrill Lynch.
- First Trust Dow Jones Internet ETF (FDN)
FDN seeks to track the price and yield performance of about 40 Internet companies included in the Dow Jones Internet Index. The fund invests in companies that derive at least 50% of their revenue online. The top 10 holdings include well-known names like Google, Amazon.com, and eBay (NASDAQ:EBAY). The fund is relatively concentrated with the top 10 holdings accounting for over 50% of the portfolio’s assets.
- PowerShares Nasdaq Internet Portfolio (NASDAQ:PNQI)
PNQI tracks the price performance and yield of over 50 Internet companies listed in the Nasdaq Internet Index. The top 10 holdings include Google, Yahoo! (NASDAQ:YHOO) and Amazon.com. This fund is also concentrated with the top 10 holdings accounting for nearly 60% of the portfolio’s assets. An interesting feature of this fund is that Chinese companies, Baidu (NASDAQ:BIDU), SINA (NASDAQ:SINA), and Sohu.com (NASDAQ:SOHU) represent about 12% of the portfolio assets.
- Merrill Lynch Internet HOLDRs (NYSE:HHH)
Bank of America’s Merrill Lynch HOLDRs offers four Internet-related investment products: Internet HOLDRs (HHH), Internet Architecture HOLDRs (NYSE:IAH), Internet Infrastructure HOLDRs (NYSE:IIH) and B2B Internet HOLDRs (NYSE:BHH).
Although HOLDRs (an acronym of Holding Company Depository Receipts) are traded like stocks on the exchanges, they do not track an underlying index. The holdings include stocks of companies with which the HOLDRs were initiated in years 1999 and 2000. Over the years, the number of holdings has declined due to exit or takeover of some of the companies. B2B Internet HOLDRs is left with just two stocks and Internet Infrastructure HOLDRs has less than 10 stocks. A notable omission in all of the Merrill Lynch HOLDRs is the industry titan Google.
Among these series of products, Internet HOLDRs (HHH) is worthy of consideration. Internet HOLDRs with 13 holdings arguably does not subject investors to the same degree of company concentration risk as the other HOLDRs. Investors in Internet HOLDRs (HHH) should however note that Amazon.com accounts for over 40% of this investment product.
Offering the above investment products to choose from, the Internet space has the potential to deliver the best ETF returns for 2011.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.