Anticipation is growing that asset managers with established ESG policies will increase their exposure to the defence sector, as Allianz Global Investors became one of the first major European firms to drop such exclusions to fund the continent’s rearmament.
Geopolitical events of the past few years “have prompted a broader rethink of the need to invest in the defence architecture in Europe”, a statement addressed to AllianzGI clients said. In this context, there is an urgency for European nations to invest more – and more collaboratively – in “a modern, resilient defence industry”.
“The narrative of the critical need for robust defence and security is spreading – so too is the recognition that sustainability finance regulation could be a hindrance to this objective. Today, defence is more and more viewed as a necessity for socio-economic development,” continued the firm’s global head of sustainable and impact investing, Matt Christensen, in an article explaining the its change of stance.
Also read: US approach to Ukraine changes the ESG conversation for defence once more
According to Christensen, AllianzGI initiated a review of the firm’s exclusion approach to defence for sustainable funds last autumn, considering regulatory requirements, market practices and its sustainability conviction. This has led to the removal of two of the defence-related exclusion criteria for the company’s mutual funds classified as Article 8 under the EU’s Sustainable Finance Disclosure Regulation (SFDR) – military equipment and services, and nuclear weapons inside the nuclear non-proliferation treaty.
However, AllianzGI will continue to refrain from investing in companies that violate international standards and regulations, alongside companies involved in controversial weapons, such as biological and chemical weapons, cluster munitions and anti-personnel mines, all of which remain excluded from sustainable funds under SFDR, given the potential indiscriminate and long-lasting environmental and social harm they can cause.
“With fiscal budgets stretched in Europe, private finance will be required to meet the funding requirements. This is, therefore, a significant opportunity for private finance, including sustainable funds under SFDR, to direct the industry on which activities can be expected to be financed, to push for much-needed improved disclosures and supply chain transparency and to consider innovative financing structures,” Christensen asserted.
Industry reaction
This was backed up by Aliénor Legendre, ESG research associate at MainStreet Partners: “Defence is now viewed as a financially attractive industry, and evolving regulatory attitudes are expected to offer investors greater flexibility in the near future – a significant departure from previous years when the sector was largely avoided.
“While some asset managers are expanding their portfolios to include nuclear and conventional weapons, many are expected to continue excluding controversial arms such as anti-personnel landmines and cluster munitions – unless their home countries choose to withdraw from relevant international agreements. Notably, countries like Poland, Lithuania and Norway are considering revisiting some of these conventions.”
EQ Investors is one firm continuing to exclude defence companies from its Sustainable Model Portfolio strategies, as they “maintain high absolute standards of sustainability”, according to portfolio manager, Tertius Bonnin.
“This aligns with our clients’ expectations regarding what should and should not be included in a sustainable investment portfolio.”
He added: “In our view, it’s absolutely critical to delineate between buying and holding shares in defence companies through the secondary market, and the overall national defence budget – into which private investors do not directly channel capital. In other words, whether sustainable investors allocate capital to defence companies or not has no bearing on overall military expenditure.
The interpretation of ‘controversial weapons’, Bonnin further noted, can be quite broad and is the subject of current debate in the market. “We know of several ESG data providers facing these questions from their clients,” he revealed. “Examples of companies commonly caught up by ‘controversial weapons’ screens include Rolls Royce (involved in the UK’s CASD nuclear submarine fleet), and BAE Systems (involved in the UK, US and French nuclear deterrent).
Despite the fervent discussion, however, Lindsey Stewart, director of stewardship research and policy at Morningstar Sustainalytics, does not believe the conditions are right for sustainable or ESG funds to rush into investing in weapons manufacturers.
“There’s broad agreement that national defence is an essential government role in which the private sector can usefully participate. But for investors with sustainable or ethical credentials, it’s often a lot more difficult to justify seeking economic upside from weapons-making activities that may extend far beyond the defence and security of any one particular nation.
“Asset managers who have avoided the sector, having previously concluded that there isn’t a sustainable outcome the sector fulfils, are likely to have difficulty finding a rationale to overturn that view. Others may well find specific opportunities in the sector that their responsible investing policies may permit them to back. So, it’s very nuanced.”
With perspectives shifting quickly, expect exclusion policies and investment strategies to continue to evolve.
