Interactive Investor

Fund trade body backs defence stocks in sustainable funds

Rishi Sunak urges investors to back defence companies, but for some sustainable fund managers the sector is off limits.

26th April 2024 09:16

by Kyle Caldwell from interactive investor

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The Investment Association (IA), the trade body for the funds industry, has said that defence investments are “compatible with environmental, social and governance (ESG) considerations”.

The comments were made this week in a joint statement with the Treasury as it was announced the UK government would commit an extra £75 billion to defence spending by 2030.

Prime Minister Rishi Sunak urged investors to back defence companies, a sector that he argues should not be shunned for ethical reasons. In addition, Sunak said the move to increase defence spending is to counter threats from “an axis of authoritarian states”.  

He said: “There is nothing more ethical than defending our way of life from those who threaten it.”

The joint statement from HM Treasury and the IA said: “Investing in defence companies contributes to our national security, defends the civil liberties we all enjoy, while delivering long-term returns for pension funds and retail investors.

“That is why the UK’s world-leading investment management industry supports our defence sector, with the IA’s members having invested £35 billion in UK defence companies.

“Investing in good, high-quality, well-run defence companies is compatible with ESG considerations as long-term sustainable investment is about helping all sectors and all companies in the economy succeed.

While the government and fund trade body have given sustainable funds the thumbs up in terms of investing in defence stocks, a long-read feature published last September by ii contributor Faith Glasgow found that the sector is very divisive.

While Morningstar Direct data (at the time of publication) showed that 25% of European sustainable funds have some exposure to defence and aerospace stocks, compared with 35% of conventional funds, some sustainable fund managers said they would never put money into defence-focused businesses.

One of those is Mike Appleby of the Liontrust Sustainable Future funds. “We have heard arguments for sustainable funds investing in weapons companies over the years, along the lines of ‘who arms the peacekeepers’,” he said. But he added that that’s no reason to change Liontrust’s stance. “Some investors do not want to profit from businesses involved in weapons systems and what they are designed to do,” added Appleby.

This view was echoed by Julia Dreblow, founder of the sustainable fund research firm SRI Services. Dreblow said: “Weapons kill people, and there are many investors who want nothing to do with companies that are involved in such activities.”

The other side of the argument is that defence companies need to raise funds. This need has increased following Russia’s invasion of Ukraine, which has caused European Nato members to allocate more money to military spending. 

A direct way to invest in defence stocks is through the Future of Defence ETF (LSE:NATP), managed by HANetf. Since launch last July it has returned 35.4%, ahead of the FTSE All World index return of around 14.5%.

Tom Bailey, head of exchange-traded fund (ETF) research at Hanetf, says the two key reasons for investors to consider having exposure to the defence sector are as a geopolitical hedge and to capitalise on higher military spending.

Bailey says: “Defence stocks provide a hedge against geopolitical shocks – such shocks have a negative effect on markets. But defence stocks typically rise, exhibiting a similar behaviour to safe-haven assets. Investors buy bonds and gold as a ‘flight-to-safety’. Investors also buy defence as a ‘flight-to-arms’.”

In terms of higher military spending, he says that among the key beneficiaries are the big European defence firms, such as Rheinmetall AG (XETRA:RHM), Leonardo (MTA:LDO), and BAE Systems (LSE:BA.).

“Global military spending is on the rise, particularly among European Nato members. For the past few decades, European Nato members have underspent, failing to meet their 2% of GDP Nato target. Several factors are changing that, from the war in Ukraine to growing concerns over the US commitment to Nato. Therefore, we believe, there is a structural shift towards higher defence spending among European NATO members,” adds Bailey.

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