“The US government is expected to sign a bill that encourages US companies to adopt more aggressive IT security spending”, which might be a boon for these service providers, Mouthon told FSA.
Similarly, in Europe, there’s a new regulation, the General Data Protection Regulation, to be implemented next year.
“[It] intends to require companies to disclose in their annual reports whether they faced cyberattacks, and the [defensive measures] to avoid such attacks in the future.
“Thus cybersecurity spending should grow faster than overall IT spending,” he said.
“For the portfolio, we are trying to find companies that have high growth potential with a reasonable price.”
The Pictet Security Fund also invests in related sectors such as security services and physical security companies. IT security stocks accounted for 26.7% of the portfolio at the end of February.
The approach is benchmark agnostic, Mouthon said. The team first screens about 350 listed security stocks, then filters out the companies with less than 20% of revenue derived from security-related business, such as financials and energy companies.
What remains is roughly 200 names. The team will then look for long-term growth potential. In the portfolio there are 65-75 companies.
M&A heavy
The fund also has a bias toward small- to mid-caps. “The security industry, in general, is very fragmented. We have a lot of small and niche players in the space that might be hard for investors to gain access to.”
For instance, a majority of the IT security stocks are from the US, but there are also a number of them from Israel, he noted.
The security industry fragmentation also explains the frequent M&A activity. There were eight instances of M&A within the fund in 2016, with an average of five deals a year since the fund’s inception in 2006.
“Our expectations are two-fold. Either we are to see the smaller players grow and become the new leaders, or these niche players will be acquired.”
One example is Symantec Corp, an endpoint cybersecurity service provider that protects access to a corporate network via endpoint devices such as laptops, mobile phones or other wireless appliances.
Last year, Symantec acquired two rivals, Bluecoat and Lifelock for $4.7bn and $2.3bn, respectively. “Since then, we’ve seen a turnaround of the company as investors were not pricing in the synergies from the acquisitions”, Mouthon said.
Commenting on some security-themed ETFs available in the US and Europe, Mouthon believes the active fund might be better positioned to invest in small- to mid-caps as they don’t have high trading liquidity.
The chart below shows the three-year performance of the Pictet Security Fund, its benchmark, the MSCI World Index, and another security-themed mutual fund from Credit Suisse Asset Management, according to FE.
