Investing in Cybersecurity and Defense

The last few years have brought about a dramatic increase in the number and sophistication of cyber security threats. More than 500 organizations globally suffered targeted cyberattacks in 2017, up 10% from 2016. The number of groups known to conduct such cyberattacks is up 60% since 2015, according to one large cybersecurity software firm’s annual internet security threat report. (1)

These threats have required both the public and private sector to increase spending on cybersecurity and defense. However, many firms and governments may still underspend on what it takes to defend against the growing threat.

For investors, this expected growth in spending can present opportunities. The average cybersecurity company has grown sales by 15% annually for the past three years to a total of nearly $300 billion, according to data compiled by Morgan Stanley Wealth Management.

Securing Our Systems

The cybersecurity sector is made up of an ever growing ecosystem of protective technologies. Subindustries within cybersecurity include firewall makers that seek to keep unauthorized users from accessing data; network forensics firms that help cybersecurity experts constantly monitor traffic and audit systems looking for a potential system weakness or intrusions; and antivirus programs that aim to block viruses and malware. Evolving forms of authentication, encryption and digital signatures can also help organizations protect their data.

Cybersecurity isn’t just for companies. Government bodies at every level are likely to increase spending on cybersecurity to prevent costly and embarrassing breaches, some of which may threaten national security.

Traditional defense spending is a way to invest in the need for stronger cyber protections alongside the general increase in global insecurity. World military spending grew at a compound annual rate of 4.2% from 1980 to 2017 (2). In the U.S., military spending growth dipped during the past decade, but since 2016, it has turned upward.

Not only do I expect that upward trend to continue, but I believe that U.S. defense spending will increase significantly in the next decade. In particular, I have my eye on the U.S.’s relationship with China. As the two nations compete for economic power, they may increasingly compete for military might as well.

An Investing Strategy

Finding the best investments takes more than identifying the market leaders. Look for companies that are generating profits from cybersecurity, gaining market share, and have strong or improving earnings growth and a reasonable valuation.

Mutual funds or exchange-traded funds are options for investors who want to add exposure to this theme. Morgan Stanley also offers a cybersecurity and defense theme through its online Access Investing platform. There, individuals can invest in a diversified portfolio with exposure tilted toward companies and sectors linked to this theme. It’s not a pure-play strategy, but it would mean more cybersecurity stocks as part of your technology sector allocation than, say, artificial-intelligence-related stocks, which is another investable theme.

At Morgan Stanley, we believe investors should remain diversified across a range of asset classes and securities, depending on their individual goals and risk tolerance. Cybersecurity is a compelling theme for the growth-oriented part of your portfolio.

Morgan Stanley’s senior leadership takes these risks very seriously and devotes considerable resources to protecting clients from cyber fraud. Learn more about how you can improve your own cybersecurity

Footnotes:

1.   2018 Internet Security Threat Report https://www.symantec.com/security-center/threat-report

2.   Stockholm International Peace Research Institute (SIPRI) Yearbook: Armaments Disarmament and International Security

https://www.sipri.org/yearbook

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected .

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging and frontier markets, since these countries may have relatively unstable governments and less established markets and economies.

Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are suitable only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

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