Volume 56 | June 4, 2024
Welcome to Brief 56, titled "Why Don't Retail Investors Invest in the Security Technology Industry?"
Once again, we are back with a quick turnaround brief from our guest writer, Tony Dong. In this Brief, Tony delves into his opinion on why retail investors hesitate to invest in the access control sector. Despite promising growth projections, these potential investors remain on the sidelines. Tony explores various structural and behavioral reasons for this reluctance, including limited representation of blue-chip stocks in the sector, geographical barriers, and a lack of suitable investment vehicles. I hope you'll find his insights enlightening and thought-provoking as much as I do.
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Why Don't Retail Investors Invest in the Security Technology Industry?
by Tony Dong
While I'm not the biggest fan of ASIS International (see here for why), they do occasionally churn out some decent data on the security industry.
One of their recent publication, "Complexities in the Global Security Market: 2024 Through 2026," developed in collaboration with the Security Industry Association (SIA) and global analytics and advisory firm Omdia, projects a rather rosy growth trajectory for the industry.
According to the report, in 2023 the security equipment market was valued at approximately $56 billion, with video surveillance accounting for about half of this figure. The market is expected to see a 9 percent year-over-year growth this year.
At the time of writing, the report noted that the largest market shares are held by China ($14.8 billion, 29%) North America ($13.6 billion, 27%), and Europe ($9.5 billion, 19%). Additionally, the non-guarding security services market, which includes installation and equipment maintenance, is anticipated to reach a substantial $117 billion by 2026.
So, why aren’t more retail investors dipping their toes into the security technology industry? By investing, I mean the average Joe or Jane owning shares in publicly traded companies. While venture capital and private equity opportunities exist (and we have a few folks here involved), they are generally out of reach for most retail investors.
I’ve explored several structural and behavioral explanations for this lack of engagement. Hopefully, as an industry, we can collaborate to address these issues and stimulate greater capital flow into these companies – as usual, I have a few ideas on how.
Limited blue-chip representation
It pains me to acknowledge this, especially considering my significant involvement in its development, but almost none of the companies featured in the ACEB Focus 10 Index qualify as blue-chip stocks, with the notable exception of Honeywell.
What exactly constitutes a blue chip? Definitions may vary, but by my standards, a blue-chip company boasts a market cap of over $100 billion, has more than 50 years of operation, pays dividends, and produces products familiar to most people.
While Honeywell easily meets these criteria, the average retail investor might struggle to recognize names like Allegion unless they're specifically interested in locks and security hardware. Even a bigger company like Johnson Controls is pretty obscure unless you work in the industry.
Why does this matter? Generally, retail investors tend to approach stock-picking in a barbell strategy: they gravitate towards either buying and holding well-established, large-cap companies (like Coca-Cola, Microsoft, or Apple) or they venture into the more speculative realm of trading risky small-caps.
The bulk of security technology firms fall into the mid-cap category—companies with market caps ranging from $2 billion to $20 billion. And thus, they remain chronically neglected. It's like being the middle child of the investing world.
Interesting enough, this segment is historically under-invested despite findings from financial experts like Christopher Cuesta, CFA, and Manish Maheshwari, CFA at Victory Capital, who highlight that mid-caps often deliver the best performance.
Geographical barriers
Another significant hurdle for retail investors in the security technology industry is home-country bias. This term describes the tendency of investors to disproportionately favor stocks from their own country relative to its overall market capitalization.
For instance, a Vanguard whitepaper indicates that Canadian investors typically allocate about 52% of their portfolios to Canadian stocks, despite Canada representing only 3% of the global market.
Similarly, in the U.S., investors allocate about 80% to U.S. stocks, though the U.S. market cap weight was about 65% in 2022. Thus, most international stocks (including security) get omitted altogether.
However, home-country bias isn’t the only issue. Accessibility to international markets presents another substantial barrier beyond the implicit difficulties of overcoming a home-country bias.
Many of the larger security technology companies trade on international exchanges without offering American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs), meaning they aren’t directly purchasable in USD.
Investors must navigate currency conversions, which adds complexity and potential costs, deterring many from venturing outside their domestic market.
Moreover, some significant players in the security technology sector are entirely inaccessible to most international investors. For example, Hangzhou Hikvision Digital Technology Co., Ltd. and Zhejiang Dahua Technology Co., Ltd. are major firms in this space.
But, both companies' A-shares are traded on the Shenzhen Stock Exchange, access to which is predominantly restricted to mainland Chinese citizens. In contrast, American investors are generally limited to H-shares, like those of Alibaba traded on the Hong Kong Exchange.
Lack of suitable vehicles
Finally, it's crucial to acknowledge that the trend towards stock picking is waning, while investment flows into vehicles like exchange-traded funds (ETFs) have surged dramatically.
This shift has spurred the creation of "thematic" ETFs, which focus on narrower trends or specific industries like clean energy, robotics, or popular right now, artificial intelligence. For example, there are currently nine cybersecurity ETFs available, according to the ETF Central Screener.
In contrast, there is a notable absence of ETFs explicitly focused on the broader security technology industry. I managed to find only one ETF that serves as a close proxy—the Global X PropTech ETF (PTEC).
This ETF tracks an index of technologies used in property management, including online marketplaces, real estate research, analytics platforms, and next-generation digital infrastructure/hardware such as smart security systems and virtual or augmented reality solutions.
Among its 32 current holdings, names familiar to those in the security technology industry include Alarm.com, Resideo, ADT, and SmartRent – most of which are in the ACEB Focus 10 Index!
However, despite its relevance, PTEC has only attracted $3.05 million in assets under management (AUM) since its launch in April 2023. This is peanuts in the ETF space.
To put it in perspective, with an expense ratio of 0.51% (the fee charged to end investors), it's very likely that it isn't generating sufficient revenue to sustain operations long term. This raises substantial concerns about its financial viability, and likely risks a potential closure in the near-term.
What can we do?
As usual, I don’t like to highlight problems without suggesting solutions. Today, I have one idea: we need to pressure industry organizations to raise awareness in a more impactful way.
ASIS should be investing in financial experts to deliver seminars on how to analyze investment prospects in the security industry, read and interpret a balance sheet / cash flow statement, or partnering with thematic ETF providers like Global X to launch co-branded ETFs. If I have to read another dull whitepaper from ASIS on "the value of ESRM," I’m going to lose my mind.
This isn't far-fetched - they already have a partnership with UPenn for an "ASIS/Wharton Security Executives Program" (no, attending that does not grant you Ivy League alumni status, so don't bother paying $12,500 for it unless your employer subsidizes it) - so why not extend their educational outreach to include financial education? Heck, I'll even do it for free.
Instead of funneling membership dollars into developing yet another credential, hosting trade shows, or conducting monotonous webinars, ASIS needs to shed their "old boys' club" mentality.
It’s time for a more dynamic and forward-thinking approach. If not, the future might see private equity or venture capital firms, perhaps advised by a few disillusioned former security tech executives, taking a more significant stake in the industry. Or worse, a conglomerate like Amazon might step in and dominate (as they are already doing with Ring).
