Cyber security: Investing in the biggest security story of our time. Cyber security has become a top priority for companies and governments worldwide and it’s easy to see why: the move to digital means that businesses have a greater reliance than ever on the internet for a huge array of functions. And can be seen from the almost daily reports of security breaches and high profile attacks, no individuals, businesses or even governments are safe. In the last year alone, we have witnessed cyber attacks on organisations of every kind, from US political parties to UK mobile phone operators.

Senior executives, rather than back-office IT teams, now have ultimate responsibility for protecting networks, data and internet-enabled devices. As a result, cyber security has become big business: an estimated $1 trillion globally will be spent on cyber security products and services between 2017 and 2021. The risk of cyber attacks has also been heightened by the growing number of internet-connected devices globally. It is expected that 200 billion smart devices will be in use by 2020.

With cyber security now a megatrend, how can investors access this growing sector?

What is cyber security?

First and foremost, the cyber security industry is not a single discipline – it involves the expertise of companies in a range of sectors, including software development, communications equipment, advisory firms and aerospace and defence companies. There is no single way companies can keep their networks, devices and data secure: training staff to look out for bogus emails is as important as keeping software up to date and encrypting the most sensitive data.

The overall goal of cyber security is to protect computer networks, programs, connected devices such as desktop computers and smartphones, and the data they hold, from unauthorised access and theft. This could be a deliberate and/or malicious attack by a cyber criminal looking to steal data to sell, a hacker looking to cause mischief or a business rival or nation state looking for sensitive information. It could also be an innocent mistake; 17.7 per cent of data breaches were caused by unintentional actions or errors, according to 2016 research by Verizon.

The cyber threat is real – and companies are spending money to tackle it

One of the unique aspects of cyber security is that cyber threats are constantly evolving: as systems and devices evolve, would-be attackers are developing loopholes to exploit them. The number of cyber threats affecting businesses reached an all-time high in 2016, including a 752 per cent jump in the varieties of ransomware seen by security experts, according to Trend Micro research.

High-profile cyber attacks are illustrative of the potential damage cyber attacks can have on a company’s reputation, revenue and future growth prospects. Yahoo last year disclosed two breaches, one affecting more than 1 billion accounts and the second around 500 million users.5 These breaches resulted in US criminal charges and caused Verizon to abandon its takeover bid of Yahoo for $350 million. In the UK, internet service provider TalkTalk had to pay a record £400,000 fine after the personal details of 150,000 customers were accessed by a cyber-attack. In the political sphere, it is alleged that Russian hackers targeted senior Democratic party figures as part of efforts to influence the outcome of last year’s US presidential election.

IDC forecasts a compound annual growth rate (CAGR) of 8.3 per cent for the cyber security industry, more than twice the rate of overall IT spending growth, between 2016 and 20207. Within cyber security, the largest areas of growth will be mobile security, Internet of Things (IoT) security, and specialised threat analysis and protection, according to Bloomberg and IDC.

How can investors access the cyber security megatrend?

Cyber security, and the organisations and products that companies use to combat the threat, will become increasingly important: regulatory requirements on data protection and privacy are set to increase, and the expansion of the Internet of Things means more objects, from phones to fridges, will have an internet connection and produce data that will need to be secured.

Governments are also making it a priority: Philip Hammond, UK Chancellor of the Exchequer, has set up the National Cyber Security Strategy, underpinned by a £1.9 billion investment, and President Trump in the US is expected to sign an executive order on cyber security in the spring.

All these elements mean businesses are likely to allocate bigger budgets to cyber security. However it is too early in the life of the cyber security megatrend to clearly identify any winners: there are many competing technologies addressing the ever-evolving threat, including the work of start-ups that haven’t yet secured patents. These smaller companies are offering innovative technologies and products, and venture capital firms invested around $8 billion in cyber security companies between 2014 and 2016. Additionally, trying to pick individual stocks among companies at such an early stage exposes investors to a higher degree of volatility than they may wish to take on.

Investment exposure to the cyber security industry therefore requires a passive approach. A global and diversified exposure can give investors access to all the elements spurring growth of the cyber security space. Typically, smaller and midcap companies have been offering the most innovative technologies and products, and so any exposure should ideally capture these players. Finally, in order to remain true to the theme, an equal-weight portfolio ensures end-to-end exposure to the whole ecosystem of companies and provides exposure to the companies that will be tomorrow’s winners.

For more information, visit etfsecurities.com/cyber

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