Investment in defence is ramping up around the world as tensions mount by the day, and US President Donald Trump has made it clear that European nations may have to take full responsibility for their own security.
Individual investors are finding they can benefit from this shift in strategic policy as defence stocks soar – by putting money into companies that focus on keeping us safe.
However, investing in such firms is far from straightforward. As well as protecting us, many also manufacture weapons that can cause devastation if they fall into the wrong hands.
So how do you invest in defence comfortably and profitably – safe in the knowledge you’re not unwittingly supporting the manufacturer of weapons designed to kill civilians, or benefiting dangerous regimes? We investigate the options.
Investment in defence is ramping up around the world as tensions mount by the day
The defence shares opportunity
Share prices in some of Europe’s best-known defence companies have soared since February, after President Trump cut off military support to Ukraine.
In response, the European Union has agreed a massive €800 billion (£660 billion) plan to increase defence spending, while Prime Minister Sir Keir Starmer has pledged to raise the UK’s defence budget from 2.3 per cent to 2.5 per cent of GDP from April 2027.
Shares in security company BAE Systems have risen 47 per cent since the start of the year; French giant Thales has gained 73 per cent; while German arms manufacturer Rheinmetall is up 130 per cent.
‘I firmly believe the Cold War peace dividend is over and we have entered a different era,’ says fund manager Job Curtis, who holds BAE in the £2.3 billion City of London Investment Trust.
‘When the Berlin War came down, countries were able to spend a lot less on defence.
‘I think we are now in a new cycle where countries are going to have to spend more.’
And this isn’t just a Europe-wide phenomenon, as Curtis expects to see increased expenditure in Asia too. Even investors who snubbed defence stocks on ethical grounds are now rethinking their views.
Funds that only invest in companies with good environmental, social and governance (ESG) credentials and may once have avoided defence stocks are now considering including them in their portfolios.
When David Coombs, Rathbones’ multi-asset fund manager, first invested in American defence contractor Lockheed Martin in 2016 he said it was viewed as ‘a very unpopular trade’.
‘Now all of a sudden people are saying, “Let’s put it into ESG strategies”. It’s amazing how these things turn around,’ he says.
When David Coombs, Rathbones’ multi-asset fund manager, first invested in American defence contractor Lockheed Martin in 2016 he said it was viewed as ‘a very unpopular trade’
Coombs suspects that fund managers won’t feel pressured to avoid defence stocks over the next five years. There appears to be political support for defence-related companies as well.
In early March, more than 100 Labour MPs and peers penned an open letter urging investment firms to ‘rethink ESG mechanisms that exclude all defence investment’.
Britain’s £28 billion sovereign wealth fund also relaxed its rules so it can now invest in ‘dual-use technologies’ – those that have both military and civilian applications.
‘I think politicians got slightly nervous because if all fund managers are encouraged not to buy, then how the hell are we as a country going to defend ourselves?’ adds Coombs. ‘We can’t do it all from public funds.’
How to invest in defence shares
If you are happy investing in defence, you may still have areas where you draw the line.
Julia Dreblow, of SRI Services, developed the Fund EcoMarket database tool to help investors research sustainable, responsible and ethical funds. To work out if you are comfortable with your investments, she suggests asking yourself three questions.
Firstly, does the company make controversial weapons, such as landmines, cluster munitions or chemical weapons? Many funds exclude companies involved in the manufacture of these weapons.
French giant Thales has gained 73 per cent since the start of the year
Secondly, does the company even manufacture weapons?
And finally, does the company have military contracts? Whatever type of company you are looking at, from cybersecurity, aerospace through to arms manufacturers, you may want to gauge which governments or regimes they are selling to.
However, in some cases this is easier said than done. Dreblow adds: ‘Lack of transparency is a massive issue, although it is understandable if they have military contracts. Who are these arms companies selling to?’
John Ditchfield, co-founder of Impact Lens which provides research on ethical and sustainable funds, agrees: ‘Part of the problem is defence businesses are large and diversified. Often they are opaque about the products and services they offer.’
Another option is to think about whether the weapons or technology produced is used for defence or offence.
This is an approach some fund managers prefer to take.
‘We try to make a distinction between investing in radar threat detection, security and cybersecurity versus manufacturers of what could be labelled “offensive weaponry”, such as missile technology,’ says Ditchfield.
What does ESG really mean in practice
Unfortunately, there is no simple labelling system to give investors a quick view of a funds’ attitude to defence.
The terms ‘ESG’, ‘ethical’ and ‘sustainable’ are often used interchangeably for funds that consider the impact of the companies that they hold. But their approach to defence stocks varies significantly.
Ethical funds will typically exclude arms manufacturers on the basis that these weapons could be used against civilians or contribute to human rights breaches. Many also exclude companies with military contracts.
Sustainable funds are unlikely to invest in arms manufacturers for the same reasons.
However, some will hold stakes in companies that produce components that are used in both military and civilian contexts, or have military contracts.
Peter Michaelis, head of sustainable investing at Liontrust, says his team has never invested in a business with significant exposure to critical weapons – a view that remains unchanged by the war in Ukraine.
‘Weapons have the capacity to inflict death and injury, as well as cause destruction to both natural and man-made capital,’ he says. ‘While I acknowledge the role of defence in maintaining security, the potential for armaments to be used by malign actors in aggression and oppression continues to make them unacceptable within our framework.’
However, the team is willing to invest in companies that build housing or provide essential services for military personnel. Michaelis said these functions support the wellbeing of individuals rather than the ‘machinery
of war’, adding: ‘Similarly, we might invest in a company that manufactures dual-use components – such as filters for hydraulic systems – used in both civilian and military aircrafts.’
Close to 12 per cent of a total of 2,487 sustainable European equity funds held up to 5 per cent of their portfolios in defence and aerospace stocks in the fourth quarter of last year, according to Morningstar’s data. This included actively managed funds, index funds and exchange-traded funds (ETFs).
By comparison, far more funds without this specific remit have an allocation to defence and aerospace – close to 30 per cent of a total of 6,604 funds.
ESG funds also vary wildly in their approach. Environmental, social and governance factors must be considered but there is no set criteria to decide how they are applied to defence. That means companies such as
BAE may well appear in ESG funds. ‘They manufacture weapons, but are not as environmentally destructive as mining companies, for example.’ says Ditchfield.
The ethical debate on investing in defence shares
Another question to ask yourself is whether you view defence companies as essential for national security and the protection of democracies. Alternatively is the potential misuse of weapons against civilians a step too far?
Fund manager Curtis believes there is a case for holding defence stocks in portfolios today.
He says: ‘If we don’t have companies that make sophisticated weapons, we are going to be at the mercy of dictators and hostile regimes. For me, defence is a social good – these companies are defending us and democracies.’
Meanwhile, Coombs can see both arguments. He holds Thales and Lockheed Martin across six of Rathbones’ multi-asset funds but completely excludes defence-related companies in the sustainable Rathbone Greenbank Multi-Asset funds he manages.
Others point to the argument that investing in defence companies gives you the opportunity to engage with the business, either directly or via a fund manager.
‘If ethical investors completely avoid the defence sector, they forfeit any influence over its direction,’ Ditchfield says.
Invest in defence without weapons
If you prefer to avoid weapons manufacturers, Ditchfield highlights cybersecurity stocks as an avenue to explore.
‘Companies like CrowdStrike are pivotal in defending against cyber threats, contributing to democratic societies,’ he says.
There are also ETFs which invest in companies that protect the digital infrastructure, including Invesco Cybersecurity and iShares Cybersecurity and Tech.
Energy security and the protection of semiconductor supply chains have also become integral to national defence, according to Ditchfield: ‘Strengthening power grids against cyber attacks and securing semiconductor supply chains are national security imperatives.’
He highlights two ETFs which tap into this theme: First Trust Bloomberg Global Semiconductor Supply Chain EFT, as well as VanEck Semiconductor ETF.
Is it a good time to invest in defence?
After two months of strong share price performance, fund managers urge caution for anyone now considering defence stocks, as the easy gains may well have been made.
Although the backdrop looks supportive for defence businesses, Curtis says they do not look cheap right now. ‘I would be a bit cautious about plunging in at the moment,’ he adds. He recently trimmed City of London Investment Trust’s position in BAE and banked some profit.
It is a similar story for Rathbones’ Coombs, who also took profits on his funds’ investments in Thales. ‘I think the market has overreacted and pulled forward ten years of military spending. Investors have become overexcited, like they did with weight-loss drugs and artificial intelligence. You need to be cautious,’ he says.
Both fund managers suggest looking out for share price weakness in the sector to buy in at a more attractive price.
Read More: How to invest in defence stocks with a clean conscience: Three key questions every invest