HACK Brings New Tech Allocation Ammo

What’s cooler than an ETF with a ticker like ‘HACK’? The way investors are using it.

It was pretty clear that “HACK,” the cybersecurity ETF that launched last November, was going to win ETF Ticker of the Year at our recent ETF.com Awards. It did, to no one’s surprise.

But what was surprising to me was discovering the variety of ways advisors are using the PureFunds ISE Cyber Security ETF (HACK). I thought for sure this fund was a siren call to alpha seekers on steroids. And maybe it is.

But plenty of asset allocators with fiduciary responsibilities to their clients in mind are among those who have helped lift HACK’s assets to almost $500 million.

To set the stage a bit, HACK came to market around Thanksgiving last year—precisely the time that crazy hacking story about Sony Pictures, North Korea and the movie “The Interview” was dominating headlines.

“When you take a look at the headlines that were going around at that time with the problems at Sony Pictures, and the cybersecurity breaches at major operations around the country from Home Depot to Target and now Anthem, you could really see that this is a business that has great growth potential,” Doug Fabian, head of Costa Mesa, California-based Fabian Wealth Strategies, told me.

Fabian was one of the few advisors who was willing to speak on the record about how his firm uses HACK, but many others had compliance concerns and only did so off the record. All of these advisors, whatever their broader approaches to technology, said none of the tech ETFs now available on the market has sufficient exposure to cybersecurity companies.

Fabian uses two niche tech funds from First Trust along with HACK; some advisors use broad plain-vanilla tech ETFs such as the Technology Select Sector SPDR Fund (XLK | A-88) with HACK; and advisor one even combined HACK with an equal-weighted tech fund, giving his clients access to tech that minimizes exposure to huge companies in the space.

Compelling Investment Thesis

Before getting under HACK’s hood, and before more closely examining these ways advisors are using HACK as bona fide fiduciaries, look at the chart below. Whatever nervousness we all feel about hacking these days seems to be good news for investors.

The chart shows HACK’s returns since its launch on Nov. 12 last year relative to the SPDR S&P 500 ETF (SPY | A-98) and XLK, the fund I mentioned above. XLK serves here as a proxy for “pure beta” tech exposure. SPY is in red; XLK is in blue; and HACK is in black.

Higher Risk & Higher Returns

The first thing that jumps out is that HACK is a relatively high-beta fund.

It rises more sharply than funds canvassing bigger slices of the market, and it certainly falls more abruptly in market pullbacks. This is because the fund is full of smaller and newer companies plying the cybersecurity space.

That definitely makes HACK a higher-risk play. But with higher risks come higher potential returns—in fact, about four times as much as either SPY or XLK since HACK’s inception. Past results don’t guarantee future returns, but there’s little doubt that cybersecurity has become and will remain a very important part of the tech world and the global economy.

Again, the advisors with whom I spoke—whether at wire houses, regional broker/dealers or at independent registered investment advisors, like Doug Fabian—are clear that other tech ETFs simply don’t have enough cybersecurity.

Asset Allocation, The New Asset Class

Some advisors are using HACK in conjunction with very broad pure-beta-style tech funds like XLK or the iShares U.S. Technology ETF (IYW | A-96).

But others, looking to minimize exposure to some of the tech sector’s behemoths like Apple, are mixing HACK with an equal-weighted fund like the Guggenheim S&P Equal Weight Technology ETF (RYT | A-74). This approach, as I noted above, tilts to relatively smaller firms that deliver slightly higher—and more volatile—expected returns over time than the broader market.

Doug Fabian favored combining HACK with the First Trust Dow Jones Internet Fund (FDN | B-59), a $2.5 billion fund that bets on “big data,” and the income-inflected First Trust Nasdaq Technology Dividend Fund (TDIV | A-69), an ETF that focuses on the dividend growth that’s now manifesting in the tech sector.

As you can see in the chart below, HACK—in fuchsia—has, since its inception, readily outperformed all the tech ETFs I’ve mentioned in this blog, including XLK (depicted in the chart above) as well as IYW, FDN, TDIV and RYT.

Charts courtesy of StockCharts.com

To be clear, this pretty picture doesn’t diminish my buy-hold-and-rebalance sensibilities. But I do recognize that my inner gambler might be well-served with a modest wager on a fund like HACK that has a lot more going for it than a cool ticker.

At the time this article was written, the author held no positions in the securities mentioned. Contact Olly Ludwig at [email protected] or follow him on Twitter @OllyLudwig.