Investors are often told that risk and return are closely intertwined – you can’t have the latter without the former.
Yet the market crash of this year has turned this theory on its head, with the tech giants responsible for much of the growth in world markets over the past decade surging ever higher while more supposedly defensive sectors have plummeted.
While this took many analysts by surprise, Gregg Guerin, senior global product specialist at First Trust, said one part of the tech sector – cybersecurity – has exhibited these characteristics for many years, making a positive return in 2018 when markets fell.
Source: First Trust/Bloomberg
However, while the cybersecurity sector often rises despite a market crash, Guerin said it can also rally because of a collapse in individual stocks.
“In 2019, 7.9 billion records were exposed by data hacks and each one of these cost $8m on average,” he explained.
“For Maersk, the largest shipping company in the world, it had to replace 45,000 computers and 4,000 servers in 2017 and it lost $400m in revenue because its terminals were down.
“So what happens when there’s a cyber-hack? Of course, people like me are made aware that I need to go and buy NortonLifeLock to secure my identity and our IT guys need to fill a contract out and get it over to CrowdStrike or Okta, all these different companies that do cybersecurity.
“But you know what happens at the portfolio level? One week, one month and three months after a big data breach, the NASDAQ Cybersecurity index actually outperforms the S&P 500.”
The opportunity set in cybersecurity is being driven by the shift towards cloud computing, which has been accelerated by the coronavirus pandemic. Guerin said this trend is being underestimated by the market and he likened it to the industrial revolution when enormous productivity gains were realised each time factories moved from being powered by water mills, then to steam and finally electricity. A good example of this can be seen in the differing experiences of the two sides of Apple’s business during the pandemic.
“Apple sells a physical product,” Guerin continued. “It’s called the iPhone. Apple came out February 18 or 19 and said: ‘We can’t make our phones right now because 700 million people in China are on lockdown and nobody can come to our factories.’
“The same company, same country and the same virus, and yet the digital opportunity is tremendous. How many copies of Star Wars could Apple have sold to 700 million quarantined Chinese people? Well, the answer is technically 700 million multiplied by the 11 Star Wars movies.
“The essence of being digital means you can have a free, perfect and instant copy, which means it could sell 700 million copies of The Empire Strikes Back in HD instantaneously at almost no cost to Apple.
“We saw Zoom go from 8.7 million users to 10.7 million users across 2019. Then it ended March 2020 with 200 million users and April 2020 with 300 million users. That’s incredible for a company that has 80 per cent profit margins and positive free cash flow.”
It is estimated that cloud computing revenues could amount to $1trn within the next five years. Unfortunately, Guerin pointed out that anything that makes this amount of money is going to attract criminals, and because cloud computing can generate revenues “anywhere on the planet while you’re sleeping, downtime is obviously atrocious”.
Aanand Venkatramanan, head of ETF investment strategies at LGIM, noted technology firms are now the most targeted industrial sector when it comes to cyber-attacks.
Guerin said that being able to both harness the power of cloud computing and play a vital role in its successful operation is why there is such an enormous opportunity in cybersecurity.
“It’s investment by necessity, companies are forced to buy your services,” he continued. “That’s a great position to be in.
“There’s awareness risk: Marriott cares if it gets hacked, because it knows you can go to Hilton and build rewards over there or go to hotels.com.
“There’s regulatory risk: how much time and money did you and your company spend on GDPR last year? How much money was made by cybersecurity because companies are forced to invest in it?”
Despite these tailwinds, many investors may wonder why they would need a specific fund focused on cybersecurity when tech already accounts for the largest weighting in a standard S&P 500 tracker.
However, Guerin said there is an easy answer to this question: not a single one of the 10 fastest-growing cybersecurity stocks is in this index.
“Zix Corporation, which screens social media and our emails, is a company that’s growing sales by 146 per cent, followed by CrowdStrike which is growing at 85 per cent.
“When people say they want to go overweight tech, everybody means Amazon. But Amazon isn’t actually classed as a tech stock anymore. How many retail investors know that when they go to buy a passive technology index?
“In the NASDAQ Cybersecurity index, CrowdStrike is now 8.5 per cent. Just to give you an idea, CrowdStrike grew its sales 85 per cent last year and has 70 per cent profit margins. This is what happens when you buy thematics.
“But the entire NASDAQ Cybersecurity index represents just 1.5 per cent of the S&P 500. Most of that is Cisco.”
Data from FE Analytics shows the First Trust Nasdaq CEA Cybersecurity ETF has made 118.65 per cent since launch in July 2015, compared with 107.01 per cent from the Gbl ETF Equity Tech Media & Telecom index and 72.75 per cent from the MSCI World index.
Performance of fund vs indices since launch
Source: FE Analytics
It has an OCF of 0.6 per cent.