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2 New ETFs Track Cybersecurity Growth

Summary Since November 2014, two tactical ETFs tracking cybersecurity have been issued. CIBR offers a reasonable expense ratio and a portfolio of companies that have performed well over the past 5 years. HACK is widely traded and offers a NAV of more than $1 billion, although that comes at a price. Businesses involved in strategies, equipment and software designed to protect data and data networks are in great demand, and will continue to be for the foreseeable future. Hardly a month goes by without the announcement of a data breach, either in the business environment or in government. The risk to data security is not limited to the U.S., either – it is a global concern. It was just a matter of time before someone offered a tactical ETF that focused on companies involved in cybersecurity 1 – the term used to refer to the particular data risks inherent to information systems. There are now two such ETFs: PureFunds ISE Cyber Security ETF (NYSEARCA: HACK ) First Trust NASDAQ CEA Cybersecurity ETF (NASDAQ: CIBR ) In the following, I examine these two funds, comparing and contrasting their investment approaches. I will also provide an estimate of their growth potential over the coming year. HACK HACK is the older of the two funds by about 7 months. Its holdings, based on the index provided by International Securities Exchange, LLC (ISE), is divided between two sectors: Infrastructure Providers and Service Providers . Infrastructure Providers are companies that develop hardware and software for cybersecurity; Service Providers are companies the business models for which is “defined by its role in providing” cybersecurity services. 2 All holdings in the fund must meet the following criteria: 3 Cybersecurity activities are a key driver of the business; Must not be listed on an exchange in a country that employs restrictions on foreign capital investment; Must have a minimum market capitalization of $100 million; Must be liquid; 4 Must be an operating company (not a pass-through security). Weighting of the holdings is determined on two levels: sector exposure is determined by the aggregate market capitalization of the holdings in each sector, and companies within a sector are weighted equally. 5 Rebalancing and reconstitution are semi-annual, in June and December. 6 Dividends are expected to be distributed monthly, while capital gains will be paid annually. 7 CIBR CIBR has been on the market for just over one month, as of this writing. Its index is based on the Consumer Electronics Association ‘s (CEA) cybersecurity classification, which requires that companies satisfy one of the following: 8 Focus on developing technologies designed to protect computer and communications networks from attack and outside unauthorized use; Involvement in deploying cybersecurity technologies to government, businesses, financial institutions and other industries; Focus on protecting priority data from unauthorized external access and exploitation. A company is eligible to be a holding of the fund if it: 9 Is classified as a cybersecurity company according to CEA requirements; Is listed on an index-eligible global stock exchange; Has a worldwide capitalization of at least $250 million; Has a three-month daily average trading volume of at least $1 million; Has a minimum free float of 20% of outstanding shares available for public trading. (In the case of companies issuing more than one security, only one holding is permitted.) Weighting is determined by the holdings’ liquidity; liquidity is determined using the three-month average daily dollar trading volume for each company. The portfolio is rebalanced quarterly, in March, June, September and December; the portfolio is reconstituted , if needed, in March and September. 10 Dividends , if any, are to be paid quarterly; capital gains will be distributed annually. 11 A Word About Dividends I would not expect either fund to pay any dividends on the basis of income received by way of dividends from their holdings. Very few of the companies in either fund’s portfolio pay dividends (fewer than one-third, in fact), and both funds use up the dividend income in covering expenses. Of course, dividends are only one source of income for an ETF, other mony coming through capital gains and interest. 12 The Holdings One would expect there to be a significant overlap in the holdings of these funds, given their tight focus; in fact, 23 companies are common to both portfolios – just over two-thirds of each. Both funds are open to holdings purchased in foreign markets, and each fund currently has six such funds, overlapping in three. Despite the fact that HACK and CIBR utilize different weighting strategies, there are six companies common to the funds’ top-ten holdings: Palo Alto Networks, Inc. (NYSE: PANW ); Cisco Systems, Inc. (NASDAQ: CSCO ); Fortinet, Inc. (NASDAQ: FTNT ); Proofpoint, Inc. (NASDAQ: PFPT ); Imperva, Inc. (NYSE: IMPV ); and Trend Micro Inc. ( OTCPK:TMICY ). Performance One should not expect much in the way of reliable performance information from new ETFs, particularly one that is less than two months old. However, the following chart shows the two funds to be dancing to the same tune, as it were: The performance of the two funds has to be taken in the context of what has been a fairly disappointing 2015 – in particular, very poor conditions have prevailed since mid-July. 13 A dismal summer has seen HACK drop from a high of $33.60 (June 23) to a close of $27.17 (August 21) – a drop of 19.14%. CIBR has pretty much seen only the downside of the market. Portfolio Performance Since a new ETF, by definition, has no extended history, when considering the potential it might have, I believe it helps to take a look at its portfolio and see how that collection of holdings has performed historically. 14 With this in mind, the following chart shows the performance of CIBR and HACK, starting from August 2, 2010: 15 (click to enlarge) Given the fact that the two portfolios overlap by about 66% of their holdings, it is no surprise that the two seem to march in lock step. However, by August 2012, CIBR begins to gradually outperform HACK, ultimately besting it by 2770bps. On an annual basis, CIBR has a CAGR of 20.75% compared to HACK’s 18.02%. There is no clear reason why the CIBR portfolio should so clearly beat HACK’s. The addition of two extra holdings should not be that much of a factor; both portfolios contain foreign equities; for sake of comparison, the standards set for CIBR’s portfolio seem marginally more stringent than the requirements established for HACK. If number of holdings is the difference, it shouldn’t be a factor to consider in choosing either fund. The indices the funds are based on are fluid in terms of content, and companies may either be added to or subtracted from the universe determined by their eligibility criteria. I should expect both indices to increase as security becomes a more pressing concern. Expectations Based on the five-year performance of their respective portfolios, the following chart shows one course these funds may track over the coming year: 16 (click to enlarge) Interestingly, the spreadsheet factored in a drop in value this month, and we are coming off one of the worse weeks the market has seen in quite a few years. In the long term, however, both funds are projected to do quite well, with CIBR expected to outperform HACK by a significant margin. 17 Assessment Both funds have a lot going for them. First Trust has a respectable history of offering responsible, quality, funds. PureFund ‘s HACK is simply huge – its NAV is currently ~ $1.36 billion , and trading volume has been significant. If there is any cautionary factor in HACK’s data, it would be its expense ratio; currently, its ER is listed at 0.75% – over the ~0.65% average for indexed funds, and well over the 0.60% ER for its competitor, CIBR. Given its NAV, an ER of that size is going to eat into income, leaving very little left for investors; not that CIBR is going to offer much in the way of dividends. Both funds are, and will continue to be, driven by developments in the cybersecurity market, and I do not see any reason to believe that market is going to drop off any time soon. If anything, as “cloud” storage becomes more and more prevalent one should expect to see increasing demand for continued research in, and development of, security solutions. The existence of an active – and persistent – hacking community will see to that. All in all, I perceive CIBR to be the better bet at this point, but the funds are too close to be able to say the choice is compelling. Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from each Company’s Prospectus, Statement of Additional Information, and fact sheets. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from The Wall Street Journal . Data from any other sources (if used) is cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. 1 Cybersecurity , in the broad sense, refers to “products (hardware/software) and services designed to protect computer hardware, software, networks and data from unauthorized access, vulnerabilities, attacks and other security breaches.” (HACK Prospectus , p. 2) HACK’s documentation refers to “cyber security,” (dividing the term into two words) while other sources use the single word. I endeavor to use the single word throughout. 2 HACK Prospectus , p. 2. 3 HACK Prospectus , p. 2. 4 This is not clarified in the Prospectus, but it is assumed to mean that the holdings must each be actively traded on the market. 5 HACK Prospectus , p. 2. 6 HACK Prospectus , p. 2. 7 HACK Prospectus , p. 13. 8 CIBR Prospectus , pp. 1-2. 9 CIBR Prospectus , p. 16. 10 CIBR Prospectus , p. 2. 11 CIBR Prospectus , p. 11. 12 My estimations of prospective dividends for new ETFs has been fairly good, so far, any difference between my calculation and the actual payments made being in the investors’ favor. 13 As I write this (Friday, August 21, 2015), the Dow has just finished the day down more than 500 points (-3.12%). 14 There are limitations to such a “backtest,” of course: it would be onerous, if not impossible, to apply a fund’s eligibility/selection criteria to the past – unless one has a lot of time and computing power, not to mention extensive access to databases. (This is why issuers of index-based ETFs pay out substantial amounts to license the indices their funds are based on.) Since not all companies currently in a portfolio have been in existence for extended period, matters of re-adjusting weightings becomes a substantial nuisance – except in the case of equal weighting. 15 Each portfolio was primed with a $25K “investment.” Each holding within the portfolio is weighted the same, throughout the trial, as it is currently weighted; in the case of companies entering the market later than August 2, the allocation they would have received is held in reserve until their entry into the portfolio. Portfolios were rebalanced and reconstituted quarterly. 16 The projection is based on the “forecast” function in Microsoft’s Excel which apparently bases its projections on an exponential trend line extrapolated from historical performance. 17 Note: these forecasts are generated by a spreadsheet, and are based on the historical performance of each fund’s portfolio holdings. This is not intended to reflect my own expectations of either fund. For my part – and as any responsible investor should realize – one cannot predict the future performance of any stock simply on the basis of past performance. At least, not with any degree of accuracy. The chart should be taken to reflect a potential tendency for future performance. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

4 Signs Your Portfolio Isn’t Ready For A Bear Market

By Ronald Delegge In case you didn’t get the memo, global stocks are now in correction mode. And the velocity of the rout has been shocking to seasoned financial pros, not to mention the investing masses. For perspective, the three largest U.S. stock benchmarks – the Dow Industrials (NYSEARCA: DIA ), Nasdaq-100 (NASDAQ: QQQ ), and S&P 500 (NYSEARCA: VOO ) are up between 129% to 258% since hitting their 2009 market bottom. Over the past month, all three U.S. stock benchmarks have shed between 9% to 13% in value. In the context of triple digit gains over the past six years, the current selloff is still just a flesh wound. (See chart below) That, however, doesn’t necessarily mean your investment portfolio is bear market ready. How would your portfolio do in a bear market of -25% losses or worse? Here are four signs that could indicate you’re not ready. Sign #1: The risk character of your portfolio is out-of-whack with reality When the risk character of an investment portfolio is incompatible with your life circumstances, your age, and your ability to tolerate risk – bad things happen. I’ve seen this sad condition consistently with the portfolios that I’ve analyzed using my Portfolio Report Card grading system. Often, it’s only after portfolios have suffered significant losses do people begin to understand their investments are far too risky and not compatible with their situation or themselves. What about the big-mouths who brag they can tolerate a 50% loss or greater inside their portfolio? These types of crash dummies are typically the first ones to jump out of the window. Sign #2: Your portfolio is 100% fully invested Wall Street likes to recommend investment portfolios that are “100% fully invested” because it allows their fee sucking institutions to maximize profits. For the individual investor, however, a fully invested portfolio is bad because it allows zero financial flexibility. For example, when stock prices (NYSEARCA: VB ) are falling, the fully invested portfolio cannot buy stocks at lower prices because it’s fully invested and falling in value just like the rest of the market. On the other hand, a portfolio with cash isn’t forced to sell assets to raise cash in order to buy stocks or whatever else at bargain prices. Take a clue from the world’s greatest investors like Warren Buffett and a tiny minority who always keep cash inside their portfolio for big opportunities. (click to enlarge) Sign #3: Your portfolio lacks a margin of safety The financial advice to “do nothing” – which is now being spewed by a certain mutual fund giant and its famous founder – incorrectly assumes that Joe and Jane Investor have architecturally sound portfolios which are built to withstand not just a friendly market climate, but a nasty one. More pointedly, the dogmatic belief that long-term investing will magically fix a broken and misaligned portfolio is ignorant. All portfolios – large, small, old, and new – should have a margin of safety. Although Graham and Dodd – the founders of value investing – talked about margin of safety in the context of selecting individual securities, it also applies to how a person assembles their investment portfolio. An investor’s margin of safety represents the money they set aside from the two other containers within their portfolio (core and non-core portfolios) to be invested in fixed accounts with principal protection. The prudent investor doesn’t wait until the house has burned to the ground to install a margin of safety inside their portfolio. They do it before the fire. Sign #4: Your portfolio is one-dimensional Any investment portfolio that is built around one asset class, one stock, or one concentrated thing is one-dimensional. And the inherent problem with one-dimensional portfolios is they aren’t adaptable. This means they aren’t equipped to provide satisfactory performance when the market cycle where they once thrived in abruptly changes. One-dimensional portfolios always have higher volatility (NYSEARCA: VXX ), higher drawdowns, and lots of unnecessary risk. And the best way to avoid having this type of poorly built portfolio is to hedge by diversifying across multiple asset classes like bonds (NYSEARCA: AGG ), commodities (NYSEARCA: GCC ), real estate (NYSEARCA: RWO ) and collectibles. Summary Your investment portfolio doesn’t need to suffer catastrophic losses before you know whether it’s able to successfully withstand a bear market. How it behaves today during volatile markets, like we’ve experienced over the past week, is a good predictor of how it is likely to perform during a market environment that is the same or worse. Don’t just observe the warning signs that your portfolio might not be ready for a bear market – but prepare ahead by fixing the flaws inside your portfolio before the storm. Ultimately, well-built portfolios aren’t just multi-dimensional in nature, but they’re designed to perform in any kind of financial climate. Disclosure: No positions Original post

Everyone Is Starting To Get It (Finally)

China is rocking worldwide markets. Some investors are getting caught off guard by the volatility. The volatility could lead to meaningful declines by year-end. On Monday morning, many investors woke up to see Dow futures down 500 points and the S&P (NYSEARCA: SPY ) futures down 3%. CNBC and Bloomberg have finally gotten the memo that the drop in the Chinese equity markets is serious. Forget Greece, forget interest rates, forget oil and forget the dollar. Those issues do not matter at the moment. The Chinese markets are in free fall and it will bring the international markets to their knees for the rest of the year. Wall street needs to come back from the Hamptons and start preparing for a serious correction. Understanding why the correction in China is not just a temporary issue requires an understanding of what pushed the market up over the past year. From June 2014 to June 2015, the Shanghai increased from 2000 to nearly 5200, a 160% increase. A large part of the run-up was funded by retail traders. Source: C alculatedRisk The Chinese markets have been largely bolstered by non-professional investors. These individuals own 85% of equities in that country. China, today, is akin to the US in 2000, when retail investors were pumping up stocks, despite truly understanding those investments. Chinese equities are rife with frauds and over-hyped companies with no tangible models of growth. These are major issues in that country and a large part of the sell-off. As those firms lose the confidence of investors, their stocks will continue to drag down the indices. With the vast majority of those involved being everyday middle-class investors, the dramatic declines will hit their consumption behavior. The Chinese economy, unlike the US, is not entirely reliant on consumer spending. Consumer spending is just ⅓ of the Chinese economy. That represents about $1.8 trillion. A large percentage of that is directed towards American products available to the Chinese people. A market decline may not cause significant GDP contraction, but will cause headaches for foreign companies in China. Source: McKinsey North American consumer discretionary companies, over the past several years, have relied heavily on growth in China to offset sluggish demand for their products in Europe and the America’s. Autos, technology manufacturers, and retailers have grown the top line, in large part, by expanding in China. If middle-class families, which represent 75% of consumer spending in that country, are seeing their wealth decline as the markets wipe out gains, they will reduce buying of American discretionary products, as the wealth effect would suggest. This is what turns this correction into a full-blown downturn for the American markets. US firms can no longer rely on China to bolster the often limited growth worldwide. Yum! Brands (NYSE: YUM ) relies on China for over half of its revenues. General Motors (NYSE: GM ), Wal-Mart (NYSE: WMT ) and just about a quarter of S&P firms are deriving the majority of their expected growth from China. Once spending in that market slows, these firms will be hard pressed in reaching their respective growth targets. The impact of the market meltdown and its effect on consumption should start to materialize in Q3 earnings and become very apparent in Q4. Investors should expect significant revisions to year-end estimates. The lowering of estimates and the eventual decline in EPS should keep the US markets lower for the remainder of 2015 and into early 2016. Markets in North America have traditionally lagged during a correction. The Asian markets began collapsing in June and the US markets are just now (as of last week) starting to fall in a serious manner. The good news, well somewhat good, is that the S&P does not tend to fall as significantly as the Shenzhen or Shanghai. While the downturn here may not be as severe, it will still cause major issues for the rest of 2015. Wall Street has gotten a pass over the past three years as the markets broadly went up. Money managers did not need to do much for returns to materialize. That is not the case going forward. Investors and professional managers need to prepare for a slow growth environment in China. A decline in the indices does not mean investors cannot make money. In July, I suggested three ETFs that trade alongside Chinese volatility. (NYSEARCA: YANG ), (NYSEARCA: YXI ), and (NYSEARCA: FXP ) are all short the Asian equity markets. Each have exploded in the past three months. If the declines persist, as I suspect, these ETFs could still have room to run. Additionally, Shorting American firms which rely heavily on China could be a great move. In June, I suggested a short on NHTC (NASDAQ: NHTC ) because that company obtains 93% of their revenue from China. That has paid off with the stock dropping by 47%. Herbalife (NYSE: HLF ) is another play here. Unlike NHTC, Herbalife has not seen a material decline in its stock, yet the company relies on China as its only growth market. If Herbalife loses growth from China, the company will massively miss the already declining revenue estimates. China is entering a downturn that will continue to wipe out trillions of wealth held by their middle class. This will turn into less consumption of American products and, therefore, lower revenue figures in the coming quarters. While the ETFs that track volatility are spiking, and may seem too risky now, there are still ample ways to make money in this market by looking at firms which disproportionately rely on China for their growth projections. Keep your eyes open and this downturn can be positive for your portfolio. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.