KCE - HACK: The Debut Fund For Tracking Cybersecurity An Industry That Still Lacks Momentum

2023-04-07 03:39:04 ET

Summary

• HACK invests in companies involved in the manufacturing of cybersecurity infrastructure as well as those focused on the provision of cybersecurity services.
• This ETF’s price could well increase in the long term as many businesses may become more reliant on protection against cyberattacks which are increasing in both frequency and severity.
• HACK might have trouble competing with its peers in the long term, not to mention past performance doesn’t depict the cybersecurity market as being especially capable of reaching notable heights.

I rate the ETFMG Prime Cyber Security ETF ( HACK ) a Hold. The cybersecurity industry continues to interest me and ETFs like this one are always intriguing. HACK is also the oldest cybersecurity ETF on the market, making it the mother of cybersecurity funds. However, this ETF still appears to underperform some of its more nascent peers. Therefore, I take a more neutral stance on this ETF despite my long-term bullish stance on the cybersecurity market.

The cybersecurity industry could see many new avenues for revenue in the long term as digital trends get stronger. At the same time, I believe that the cybersecurity industry may have a general lack of momentum compared to the rest of the technology sector. Alternative industries that investors could tap into include cloud computing and software. These industries seem to be more capable of outperforming the technology sector and the rest of the market alike. However, these industries are also more volatile and prone to greater price fluctuations, making them a little more of a gamble compared to cybersecurity.

Therefore, HACK might be for those who are willing to wait slightly longer for generated alpha, but also possibly endure less severe price fluctuations along the way. This could make for a relatively smoother ride, but one that might not go the same distance as other technology ETFs like the ones depicted in the charts below.

Strategy

This ETF tracks the Prime Cyber Defense NR USD Index and uses a full replication technique. However, via this ETF's prospectus , HACK may also employ a representative sampling strategy when full replication could detriment investors.

HACK divides the cybersecurity market into companies focused on the development of cybersecurity appliances and those focused on the provision of cybersecurity services. This ETF aims to equally weight stocks within both segments. This is accomplished by weighing each segments' market cap in respect to the whole cybersecurity market, and then making adjustments for purposes of liquidity. This strategy has given HACK somewhat of a small-tilt compared to its benchmark as well as a unique focus on software and IT technologies.

Holdings Analysis

This ETF holds primarily technology stocks while also dedicating a mere 10% to industrials. These companies are located mainly in the United States, with minor appearances from Eastern Europe, Japan, and Canada.

The top 10 holdings in this fund account for 47% of the total holdings while the top 25 comprise 91%. Given that HACK only consists of 60 stocks, this ETF could be considered quite top-heavy. Therefore, though this ETF appears to be somewhat less volatile than other technology funds, investors might still want to consider the possible threats stemming from concentration risk.

Strengths

The cybersecurity industry has fairly strong growth forecasts, which could eventually translate to increased returns for investors. The North America cybersecurity market is forecasted to grow to over $376B by 2029 at a rate of 13%.

This growth could be especially fueled by increasing cybercrime across various sectors, not just technology. Businesses continuously digitizing many of their operations is concurrently providing an abundance of new targets to hackers. With the exception of the technology sector, such businesses are primarily in financials and healthcare . I specifically address the rise of cybercrime towards financial service in my recent coverage of the SPDR S&P Capital Markets ETF (KCE). This emerging threat could increase the demand for cybersecurity solutions as well as establish these services as more of a necessity rather than a luxury.

HACK is also pretty liquid, which could be attributable to its slightly higher AUM compared to that of other, smaller cybersecurity funds.

This component could narrow the bid-ask spread of this ETF, which could reduce pricing issues and also create more trading opportunities for investors. Though I believe investors could profit with HACK in the long term if they're patient, one could also easily sell their shares for a decent price if they decided to sell at an earlier moment.

Weaknesses

HACK has consistently underperformed several of its alternatives during the last three years, as seen in the chart below.

As I'm conducting this analysis with a 3-5 year timeframe in mind, this ETF might not have the same propensities for growth as similar ETFs that investors could just as easily pick over HACK.

This ETF also has higher expenses than all of the other ETFs depicted on the chart above. Buying this ETF might involve overpaying for an asset that doesn't necessarily appear to offer that many edges against cheaper alternatives, at least on the basis of past performance.

Opportunities

Cyberattacks could become a primary threat to United States businesses in the long-term. Such incidents on behalf of foreign belligerents like China and Russia are also likely to enhance this threat and also contribute to geopolitical tensions.

Though an increasing number of hackers at large could put cybersecurity services to the test. Alternatively, cyberattacks could also drive the demand of certain cybersecurity solutions if these solutions prove effective at protecting data. This could create new sources of revenue for companies held in HACK.

The series of regional bank collapses last month led many investors flocking to technology stocks as safe haven assets . This manifested as the prices of several big tech stocks climbed shortly after the debacle. Though this was a momentary impact, I still believe this event could have meaningful long-term implications for the financial sector and technology sectors alike. In specific, worry over the stability and profitability of the United States financial system still lingers in some investors. Ultimately, many could find a silver lining in technology assets like HACK in the coming periods.

Threats

The Malware-as-a-Service (MaaS) industry could become a significant threat to the cybersecurity market in the future. MaaS involves the distribution of malicious software (Malware) to parties that could use it for cybercrime. Malware consists of programs or code whose sole purpose is to sabotage or breach electronic systems.

MaaS organizations make it easier for individuals with limited technological expertise to carry out cyberattacks. Therefore, these organizations' expansion could proliferate the number of hackers on the loose. This could concurrently increase the pressure towards cybersecurity companies to fend off this threat that could become overbearing. Furthermore, the talent shortage within the cybersecurity job market persisting can only invigorate this danger.

Conclusions

ETF Quality Opinion

HACK could provide quality exposure to the cybersecurity industry, a market which could have many opportunities for growth in the long-term. However, I am still questioning how capable this ETF is of outperforming both its peers in cybersecurity as well as other technology subsectors in the long term. For these reasons, I plan to watch HACK closely in the coming periods.

ETF Investment Opinion

This ETF is a quality asset at its core, but HACK along with some of its alternatives are currently overvalued and continuing to battle treacherous market conditions. On this note, I rate HACK a hold for the time being. I also believe that when a better time comes to invest in cybersecurity, this ETF's alternatives might make more compelling buys. I also don't particularly believe one should sell HACK, as they could reap benefits in the long term. This development might take a little while just based on what's been observed in past trends, and some serious patience may be demanded from investors.

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