Defence companies were once shunned by environment, social and governance (ESG) investors much like oil and tobacco companies are, but attitudes have reversed dramatically in recent years – a new study by HANetf found that 94% of wealth managers now consider defence companies to be ESG stocks.
Times have changed since the invasion of Ukraine, which forced ESG investors to reconsider their automatic exemption of defence sector stocks.
When it became clear that these businesses were crucial to protecting against hostile nations, large banks such as Sweden’s SEB reversed their bans on defence stocks within a month of the invasion, and most other financial institutions have since followed suit.
Yet despite this pivot in attitudes, defence companies are far from spotless, according to HANetf’s head of research Tom Bailey. There were multiple difficulties to navigate when the firm created its own thematic ETF – namely where defence companies were located and who they were selling to.
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“Investing in defence can be controversial,” Bailey said. “Just a few years ago there were calls for defence companies to receive automatic exclusion from certain indices. Such attitudes, however, are now changing.
“But how does defence fit into a world concerned with ESG principles? If ESG is about incorporating non-financial data into investing to mitigate risk, when it comes to defence, a screen to ensure companies tied to geopolitically hostile actors are excluded is vital.”
To avoid this risk as much as possible, the Future of Defence UCITS ETF – a fund born from this increased demand in July last year – only invests in defence companies domiciled in NATO countries.
However, while NATO-domiciled defence companies have appeased ESG investors by supporting Ukraine, they also supply 100% of arms to the Israel Defense Forces, which has displayed “clear evidence” of war crimes, according to UN Human Rights Council.
Regional exclusion is not without risk, but is more pragmatic than traditional ESG criteria, according to Bailey, who added: “When it comes to defence, traditional ESG screens fail to incorporate the most important ‘non-financial metric’ – geopolitical exposure/risk. The biggest risk is finding yourself exposed to companies producing arms for potential rival countries we may one day face hostilities with or may act in a geopolitically aggressive way.”
Since launching last year, the Future of Defence UCITS ETF is up 36.6% and has attracted $386m (£295m) in assets under management (AUM).
This article first appeared on PA Future’s sister site Portfolio Adviser
