Cybersecurity companies have been benefiting from growing adoption, and this pandemic has only accelerated the secular tailwinds behind this mega-trend. However, as the industry develops, it has become overcrowded, and picking the “best of breed” companies is nothing short of challenging even for seasoned tech investors.
Michael Loukas, Principal & CEO of TrueMark Investments, provider of the actively-managed ETF Artificial Intelligence and Deep Learning (LRNZ), spoke with ETF Trends via a Q&A concerning current cyber trends and how to benefit from these best of breed companies and more.
What are you telling tech investors now?
We believe that this has been an opportunity to commit cash. Generally, when we see slow, grinding bear market downturns based on the chronic deterioration of long-term economic or fundamental conditions, we exercise caution when “buying the dips.” Examples would be the 2008 housing bubble or the 2000-2002 internet bubble that humbled NASDAQ. However, when we see a sharp downturn caused by sudden, unforeseen events (like the current pandemic, natural disasters etc.), we believe investors should be aggressive in stepping in with available cash. We’ve been able to execute on this during the current downturn and our portfolios have benefited thus far. Of course, we don’t suggest abandoning your investment premise, but if the decline presents an attractive entry point to stocks that you liked in Q4, and their competitive advantage hasn’t changed, then we try to take advantage of it.
Where were things heading in 2020 before the industry was affected by Covid-19?
In our view, heading into 2020, the tech sector was generally in pretty healthy shape. That stance hasn’t changed much. Because we tend to invest in long-term secular growth companies that are in the “fat part” of their hypergrowth curve, our names were doing well heading into Q1, and we expect them to continue to do well. This is an important factor, which relates back to our first answer. If you felt that the pandemic simply exposed underlying weakness in economic fundamentals, you may have a different perspective. Concerning the tech sector, more specifically, the AI & Deep Learning segment, we felt that fundamentals were solid, and the pandemic has only enhanced the segment’s potential.
What are some significant changes that have affected these business models?
That’s the great thing about many tech segments; there have been very few changes, if any. I think we’ll see major, potentially ground-shaking shifts in traditional economy business models, but far less in tech/New Economy business models. These are predicated on an evolving society and ever-changing work environments. The digitalization of society and the workplace isn’t a new theme, but it just became very real for a lot of people, not only for Americans but globally. Certain tech segments will emerge from this downturn in even stronger conditions, such as cybersecurity. I think customers quickly recognize an accelerated need for it.
What are the benefits of “work from home” trade?
Many companies in the cybersecurity and SaaS sectors have been major beneficiaries of the shift to WFH initiatives. As I touched on earlier, the pandemic has accelerated the recognition of need in these areas. Certain tech companies have been utilizing these tools and applications for some time, but the current environment has expedited the implementation in a much broader cross-section of businesses. For many non-tech companies, these are the types of things that were collecting dust in their disaster recovery plans, not front-burner budget items… until now.
How do you pick the “best of breed” companies? Are their historical metrics to rely on? New ones developed because of changing circumstances?
Our focus is on identifying new tech markets/segments, therefore changing circumstances certainly can lead to the exploration of new segments; however, our process is much more dependent on a qualitative assessment of a company’s fundamentals dating back to its early stages. It’s not uncommon for an emerging tech company to enter our research universe while it’s still private, but there just isn’t enough financial information to analyze at that stage. In that type of environment, it’s just as helpful for us to devote more of our resources gauging how well the company’s products are performing and, perhaps most importantly, the level of customer satisfaction with those products. Our goal is to identify the potential “winners” of a new tech segment and consolidate into the clear leader as it emerges. We believe tech is a “winner take all” industry.
What helps CRWD, PD, and OKTA stand out in a crowded cybersecurity market?
Simply put, we expect each of these companies to be the winners of their respective product and market categories. We feel that each of these companies utilize AI in a way that gives them a competitive advantage over their peers. Additionally, their products exist in new tech segments that have entered or are showing the potential of entering a hypergrowth phase. For all of them, their fundamentals are actually accelerating through the downturn. Think of it this way: It’s the combination of a Peter Lynch-type consumer and trend analysis with a profound understanding of the tech product pipeline and where these tech segments are headed. Companies like OKTA (Identity management, access applications such as face id, two-factor authorization, etc.), PD (actually predicting what can go wrong with IT systems, freeing up 80-90% of the resources spent fixing network issues), CRWD (perpetually improving cybersecurity applications IN REAL TIME), make complete sense when people realize what they do. The goal is to identify them as category winners long before consumer demand accelerates and propels them into a hypergrowth phase.
What anticipation do you have for the near future in regards to cybersecurity trends?
As prevalent as cybersecurity is, it’s still in the early stages of its growth curve. My good friend Roderick Jones over at Rubica has been pounding the table on this in Silicon Valley for years and years. As we become a tech-based society, cybersecurity will be one of the most important factors of the economy. Identity protection, information security, national security, the list is endless. As with many of our responses, it often takes an accelerant for companies and individuals alike to move it to the front burner. This pandemic has at least shined a spotlight on it.
What is there to make of a time when things turn back to normal (or at least close to normal), and the trend heads a different direction?
Define “normal”! The normal that we knew in 2019 will never return. Some changes may be subtle, some may be foundation rattling, but there will be a noticeable change. In truth, it’s a path society was already on, this pandemic simply served to accelerate the early stages. That subject could be a discussion unto itself. However, with regard to our portfolios, we don’t expect any let-up in trend. The secular growth nature of these companies and the markets they serve should preclude any reversion.
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