By Trevor Hunnicutt
NEW YORK (Reuters) - One year after a set of high-profile cyber attacks and a hot market for trendy exchange traded funds propelled the PureFunds ISE Cyber Security ETF to one of the most successful ETF launches in history, it is facing a major test of its investment strategy.
In the first nine months after its November 2014 launch, HACK raised $1.4 billion in assets, making it the third fastest growing new ETF in 2014 and the fastest from a small company, according to Lipper.
But even though spending on cyber security has not abated, and even though some standout stocks in that sector have soared in 2015, HACK itself is down 1.0 percent this year through Monday.
That is raising questions about whether a passively managed index fund, narrowly focused on a diverse but small industry group, can reward investors. A similar fund, the First Trust NASDAQ CEA Cybersecurity ETF, has fallen 11 percent since its July launch.
HACK's performance problems may be a function of the way the ETF is organized. It is a passive fund, so there's no manager who can pick winners and losers in a field where the performance difference between them is stark.
And instead of being based, as many index funds are, on a market capitalization index in which the biggest companies are weighted the heaviest, the fund has a complex structure that comes close to weighing every company in its portfolio equally.
That has meant Imperva Inc, with a 57 percent return over the last year, and Barracuda Networks Inc, which is down 46 percent, contribute equally to returns.
Furthermore, the fund owns a wide variety of broad technology stocks such as Symantec Corp (O:SYMC), which is down 22 percent this year, and Juniper Networks Inc (N:JNPR) that may have a cybersecurity presence but may also get whipsawed by unrelated issues.
For example, last week Juniper stock fell 7.8 percent in a day after the announcement of a telecommunications partnership between its rival Cisco Systems Inc (O:CSCO) and Ericsson (ST:ERICAs).
"What we've seen this year is some of these stocks perform excellently, and some of them don't," said Todd Rosenbluth, a research director at S&P Capital IQ who has been critical of the fund for having a mishmash of stocks. "But you're not buying this to offset the winners and the laggards in cyber security."
He suggests that cyber security is one area where investors might do better to pick well-valued individual stocks, but PureFunds CEO Andrew Chanin counters that "you expose yourself to significant company risk" when you do that.
He said HACK, which grew 34 percent from its Nov. 14 launch through June 23 before it started reversing in a broader technology selloff, is a victim of technology investors "throwing the baby out with the bathwater." New regulations, mergers and acquisitions and ever-more sophisticated cyber attacks could still drive the fund's growth.
But Rosenbluth is not so sure. "This is going to continue to be a volatile ETF," he said.