Technology continues to change our lives – mostly for the better. Whether it is advances in medical care like less invasive surgery, cheaper and better energy production via hydraulic fracturing, onshoring more manufacturing via robotics or improving the safety of our automobiles, aircraft and other modes of transportation, technology is everywhere around us and everywhere having an impact.
Many of the companies investing the most in technology are not considered “tech companies” because they are on the leading edge of technology uses well beyond Silicon Valley.
Innovation is where you find it. For me, limiting my interest to “internet-based” tech like browsers and big data domination, or “social media” leadership, or “e-retailing” hegemony misses the whole point of how technology can be a force for powering the economy and energizing industry.
If you disagree and want only those companies in quotation marks above, almost any passive cap-weighted ETF will do. PowerShares QQQ Trust Series 1 (QQQ, Financial) and Fidelity Nasdaq Composite Index Tracking Stock (ONEQ, Financial), while not really “tech” funds (but are cap-weighted), have portfolios dominated by tech companies. For purer-play ETFs like iShares Global Tech (IXN, Financial), SPDR Select Sector Fund - Technology (XLK, Financial), Vanguard Information Tech ETF - DNQ (VGT, Financial), Fidelity MSCI Information Technology Index (FTEC, Financial), iShares U.S. Technology (IYW, Financial) and iShares North American Tech (IGM, Financial), the percentage of portfolio in techs is even higher.
From a purely investment standpoint, the most successful way to have profited from tech stocks in the past couple of years has been to buy the FAANGs (Facebook [FB], Apple [AAPL], Amazon [AMZN], Netflix [NFLX] and the different iterations of Google). The next best was to buy ETFs like those above since the FAANGs are typically 20% to 40% or more of their portfolios. It is a given in many quarters that the question isn’t if but when everything we do will be either controlled by or of direct and immediate benefit and massive profit to these companies so there was no concern for what price one paid.
The big discussion on tech message boards was more about whether Google would conquer all – or would it be Amazon? Such narratives are dangerous. Thinking in a linear fashion – that what is will continue to be and can be meaningfully extrapolated into the distant future – or in a binary way – that if Outcome A doesn’t happen that means that Outcome B must – are sure paths to a pauper’s grave. Right now, critical thinking and a little review of history are of far greater value.
John D. Rockefeller’s Standard Oil empire was to the industrial age and automobile transportation infancy what today’s FAANGs are for many: an unstoppable force. Until the politicians stepped in as they did with DuPont, the New Haven Railroad and 40 others. A politician can destroy a hegemon in the blink of a regulation or the hint of a busted trust!
More recently, when Apple looked to be down for the count, Microsoft (MSFT) was the company in every institutional portfolio. The future was computing, and Microsoft controlled the operating system that allowed us to compute. Then Microsoft took a hard fall. It took a complete reassessment and a lot of innovation for Microsoft to regain some of its former glory. (But FAMNAGs just doesn’t roll off the tongue as trippingly so Microsoft is unlikely to bump through into the higher acronymic atmosphere.)
Even if no rabble-rousing politician or politicians change the course of these companies’ success, some of us are reluctant to buy something so highly valued in what may prove to be so late in the cycle. I just can’t bring myself to pay close to 200 times earnings and receive not a penny in dividends from the likes of Amazon or Netflix, brilliant companies with first-mover advantage and moats they are reinforcing and expanding daily.
I try never to let my respect for a company or its management or its service cloud my judgment as to the value of its shares at a given price. I can love Amazon (and do) without thinking its stock “has to” continue on its current linear route with nary a bump in the road.
That brings us to equal-weighted tech ETFs. They make more sense, at least on paper, and in a “normal” market – whatever that is – they will provide better diversification and might also provide better total returns. But not lately. The mo(mentum) has clearly been with the mega-giants that comprise the FAANGs and a few of their closest friends (NVIDIA [NVDA], Microsoft, etc.). To buy into the equal-weighted philosophy is easy, but the reality has been that you have been left well behind the major tech moves if you did so – up until now anyway. Guggenheim S&P 500 Equal Weight Technology (RYT) is the best known of these, but Direxion NASDAQ-100 Equal Weighted Index Shares (QQQE) and First Trust NASDAQ-100 Equal Weighted Index Fund (QQEW) are also reasonably sized players in this space.
Going global is not difficult. Many passive cap-weighted tech ETFs invest globally, not just in the U.S. The exception is if the index is a subset of the Standard & Poor's 500 – S&P banished foreign names from the S&P 500 a while ago so if getting a piece of TenCent (HKSE:00700) or Baidu (BIDU) or whatever foreign security you’d like to own you probably don’t want to buy SPDR Select Sector Fund.
Then there is the way I am currently investing for my family accounts and clients. I don’t always mind passive – as long as I control the sector / subsector decision, whether it is domestic or global and fundamentally or equally or cap-weighted.
No matter how you slice it, any bet on tech involves a guess / forecast / prognostication about what our world will look like in coming years and how technological solutions will solve problems and form new industries. And as I suggested above, the technology that created the ability for horizontal fracturing with high-speed drills and better seismic data will make North America the new Middle East of gas and oil. For the benefits to the economy, the work force and the national defense, this tech innovation is at least on a par with e-tailing or social media.
I am not discounting the intellectual and culture-changing significance of e-tailing and social media or the encyclopedic value of having searched-for information available at our fingertips. But if you didn’t already jump on board, there are better valuations and similar growth to be found elsewhere. A move from 950 to 1,250 is impressive! But no different, in terms of portfolio return, than a move from 95 to 125 – or 9½ to 12½.
I see three subsectors with the greatest combination of (1) world-changing innovation and (2) valuations that are reasonable given their growth prospects.
The three areas I see the greatest future for are:
- Cybersecurity.
- Robotics.
- Artificial intelligence (AI).
In the intelligence community we long ago treated hacking, spoofing, phishing and such as what it is: cyberwarfare. The corporate, nondefense and intelligence government agencies, and individual users as well, are now beginning to realize this is not only warfare, it is truly The Long War.
It doesn’t matter how secure you believe you are. Some sad little nonentity is working in his mom’s basement to penetrate your defenses, steal your data, encrypt it then ransom it back to you (if they feel like it after they’ve gotten your money). Or maybe he’ll only destroy all your most important files just because he’s a malicious little SOB.
Magnify this scenario 1,000 times and put billions of dollars and tens of thousands of government hackers behind it and you have Russian, Chinese or other propaganda delivered by parties separated 15 or 150 removed from the true source; plans by potential adversaries to knock out electric power, water and sewer, etc., in midwinter; asymmetrically knock out battlefield innovations like GPS and IFF (Identification Friend or Foe) and so on. All without firing a single shot. Cybersecurity is an industry really in its infancy. We all need to do a better job of protecting everything from our personal files to our national infrastructure.
The way we do this is called “cybersecurity.” Cybersecurity is the corpus of physical protection and various technologies and processes designed to protect networks, data and computers from damage, attack or any kind of unauthorized access. It also involves a component not always considered when defining it but critical to success: end-user education.
I use the analogy of electronic warfare to place cybersecurity in context. The moment an adversary reaches a breakthrough in electronic warfare, we need to find a counter-EW technology or process. Then the enemy creates a counter-counter EQW platform or process.
Like EW, cybersecurity is constantly evolving. One of the Department of Defense prime cybersecurity contractors is CA Technologies. One of its CTOs before CA acquired Layer 7 Technologies said it best a few years ago:
"The threat is advancing quicker than we can keep up with it. The threat changes faster than our idea of the risk. It's no longer possible to write a large white paper about the risk to a particular system. You would be rewriting the white paper constantly."
How big is the cybersecurity market? Big enough to accommodate every firm in every cybersecurity ETF. According to Forbes, the global cybersecurity market reached $75 billion for 2015 and is expected to hit $170 billion in 2020.
There are two fine ETFs in the cybersecurity industry. I like them both equally well and own roughly equivalent amounts of each. The first is the PureFunds ISE Cyber Security ETF (HACK.) Its biggest holdings include Palo Alto Networks (PANW), Akamai Technologies (AKAM), Barracuda Networks (CUDA), Gigamon (GIMO) and FireEye (FEYE). The First Trust NASDAQ Cybersecurity ETF (CIBR) shares its two top spots with those of PureFunds but then follows these with Cisco (CSCO), Juniper Networks (JNPR) and Symantec (SYMC).
Both have the same management expense (0.6%) though PureFunds is the older of the two (by a few months) and hence got the bigger share of total assets. PureFunds has $1.14 billion in assets and average volume of 318,000 shares per day traded. First Trust has $263 million in assets and trades just over 66,000 per day on average. PureFunds has more smaller firms which may be more nimble; First Trust has more large, better-capitalized companies in its stable. Both are well worth your consideration.
If I were only to buy one, it would be First Trust. It is volume-weighted rather than cap-weighted so it attracts more liquid holdings. Personally I like bigger (maybe slower) firms with deeper pockets. We’re talking a $170 billion-sized pie in three years. Those firms with the deepest pockets will spend the most on R&D and acquire many of the younger firms. I also really respect First Trust’s research methodology.
Who’s guarding your personal information?
Moving on, many investors confuse robotics and artificial intelligence. Some robotic applications require the use of artificial intelligence but many do not. The bad thing about humans is that we can be whip-smart intelligent but often the more intelligent we are the more easily we become bored. Computers, at least so far, don’t get bored. Programmed with a repetitive task such as on an assembly line, those robotic assemblies designed, controlled and maintained by humans will do the same task in the same way at the same point hundreds of thousands of times.
Enter Robo – the Robo Global Robotics and Automation ETF (ROBO). Robo is very much a global ETF. Clearly the U.S. doesn’t have a lock on great automation companies. Notably missing among Robo’s top 25 holdings are mainland China firms – for good reason. (There is just one that makes the cut, at 1.65% of the portfolio.) Nine Japanese companies are represented, though, with Switzerland, Taiwan, Germany and Finland rounding out the roster along with 11 U.S. firms. Of course, China’s problems are less about efficient use of new technologies than about keeping a potentially restive population employed.
Among Robo’s top holdings are iRobot (IRBT), Aerovironment (AVAV), Japan’s Daifuku (TSE:6383), Intuitive Surgical (ISRG) and Japan’s Keyence Corp. (TSE:6861). Given this global perspective and the cost of doing business on other world exchanges, Robo has expenses of 0.95%. It has total assets of $750 million and average daily volume in excess of 130,000 shares traded.
What’s to like or not like about Robo? Depending on your perspective, both answers are the same. The parent ETF provider has just one offering – Robo in the U.S. and a clone fund for the EU. So it conceived of the index its ETF is following. That may seem a bit incestuous to some. Or it is simply passionate about its product and focused on its success. You decide. One way to do that is to visit its Web site.
Finally, if you are looking for an ETF that features companies applying artificial intelligence in the real world, you might consider the ARK Industrial Innovation ETF (ARKQ). ARK Industrial Innovation is likely to be more volatile than the others so a smaller position may be warranted for those who don’t care for volatility. Why might it be more volatile? Well, its top five holdings comprise 40% of the portfolio, and they are all market darlings that have risen astronomically over the past few years.
They are: Tesla (TSLA), of which I am not a particular fan, Israel’s Sratasys (SSYS), NVIDIA, Proto Labs (PRLB) and Amazon. You want momentum stocks? This ETF's got big mo – which of course can up and bite you on the downside. ARK has an expense ratio of 0.75% and average daily trading volume of just 25,000. Enter limit orders!
This is an actively traded fund, not passive, with a manager-defined roster of industries, primarily those in the robotics, 3D printing and autonomous vehicle arena. Such narrow-focus funds with large amounts in one or two or a half dozen companies live by the growth sword or die by the growth sword. This is an exciting area, and there is lots of good news yet to come as there are breakthroughs being made every day in this field, but I still consider this the riskiest of the three subsectors covered here.
It is also a thematic ETF with a difficult to pin down theme; “industrial innovation” can take many forms and if portfolio manager Catherine Wood decides company XYZ is quite the innovator (in their opinion) they can add it. You, as the owner of this ETF, may decide that’s not what you thought they meant.
The ETF has a 94% “active share” versus the S&P. That doesn’t mean it is uncorrelated to what happens in the stock markets, but it does mean that if you want to diversify beyond the S&P here’s a fund that has 94% of its portfolio in the stock of companies that are not in the S&P 500.
Given ARK’s momentum bias it isn’t surprising that the company I believe will once more reinvent itself, this time as the leader in AI, isn’t even in the top 25 holdings. I refer of course to IBM (IBM). Love it or hate it, never discount IBM’s ability to rise from the ashes.
But that’s a story for a whole ‘nuther article. Concluding this one, my trifecta of ETFs in the three tech areas I believe offer the greatest reward over the coming five to 10 years are, in order of my personal preference, First Trust (and/or PureFunds), closely followed by Robo, with ARK, a momentum favorite, receiving the smallest share of my portfolio.
Please remember, these ETFs invest in volatile industries! I suggest trailing stops, especially on ARK. In my case, this late in a wonderful bull, buying into these leading edge subsectors, I’m keeping stops very tight at 5% or so. Better to cut losses and buy again, hopefully at least another 5% below our selling price. That’s short term. Long term, all three will reward me quite well.
Disclosure: I own First Trust, PureFunds and Robo. I have a limit order to buy ARK.
