These cyber and defense ETFs are beating the market. Here’s what investors need to know

Published Wed, Mar 2 202211:38 AM ESTUpdated Wed, Mar 2 20221:24 PM EST

Jesse Pound @/in/jesse-pound @jesserpound

Traditional and modern defense stocks rose in February as Russia invaded Ukraine, with several exchange traded funds focused on the space gaining despite a broader market sell-off. The biggest ETFs focused on aerospace and defense surged in late February, with the SPDR S & P Aerospace & Defense ETF (XAR) rising more than 11% for the month. The fund's top holdings include names such as Mercury Systems , Lockheed Martin and Northrop Grumman . Information security funds outperformed as well, with the iShares Cybersecurity & Tech ETF (IHAK) and the First Trust NASDQ Cybersecurity ETF (CIBR) rising 3.1% and 5%, respectively. Outside of the pure-play sector funds, investors may need to look at smaller funds to get exposure to both traditional defense and cyber in one group. Of the above list, the SPDR S & P Kensho Future Defense ETF (FITE) is the smallest with about $27 million of assets under management. The fund rose more than 6% in February, and its top holdings are Lockheed Martin and Check Point Software Technologies . The Strategas Global Policy Opportunities ETF (SAGP) is another smaller fund that has a mix of traditional defense and cyber. The fund, based on an analysis of "lobbying intensity," launched earlier this year as a public version of a private vehicle the firm has offered for years. The fund, which also has exposure to other sectors like pharmaceuticals, rose more than 2% in February. To be sure, defense-focused stocks could decline if the war in Ukraine winds down. Many Wall Street strategists have cautioned in recent weeks that market turmoil from geopolitical events is often brief. However, Dan Clifton, the head of policy research at Strategas, said the conflict could help the companies get a new defense budget that makes it easier for them to offset inflation. "What I think is happening here is that even before Ukraine really came on the radar screen, you have a lot of these defense companies that are in Washington lobbying, stressing that they can't have flat revenue and higher costs," Clifton said. "There's been this push to get the defense budget passed, and I think Ukraine basically pushes this over the finish line." Morgan Stanley analyst Kristine Liwag also pointed to higher defense spending as a reason for raising price targets on defense stocks in a note to clients on Wednesday. "This higher opportunity in the out years supports the multiple expansion. However, it is too early to factor in this potentially higher growth in earnings estimates as government contracts take time to convert to revenue," Liwag said. The increased defense spending in Europe, particularly from Germany, could make international defense stocks such as Britain's BAE Systems longer-term winners as well, Clifton said. "The German decision to increase defense spending is a major factor here. And what SAGP does is it has an international allocation… We actually have exposure to international defense companies that are likely going to benefit from this," he said. For cybersecurity stocks, the war could motivate private companies to beef up their security spending in case of retaliatory attacks from Russia or in future conflicts. "The sanctions by the West are so tough on Russia… They're likely going to respond on a cyber basis. And that means that companies are going to have prepare for their cyber hits," Clifton said. — CNBC's Michael Bloom contributed to this report.

A Lockheed Martin F-35 aircraft is seen at the ILA Air Show in Berlin, Germany, April 25, 2018.

Axel Schmidt | Reuters

Traditional and modern defense stocks rose in February as Russia invaded Ukraine, with several exchange traded funds focused on the space gaining despite a broader market sell-off.