Are Defense Stocks Becoming Ethical Investments?

In the past few months, Europe’s defense sector has been feted by politicians. In the UK, prime minister Rishi Sunak announced in late April that he was putting the country’s defense industry on a war footing, echoing similar comments by French president Emmanuel Macron made just a few weeks earlier.¹

Since Russia’s invasion of Ukraine in 2022, European countries have realized that they must strengthen their militaries and revitalize defense industries. Otherwise they will not be able to protect the continent’s democracies.

This shift in sentiment has become stronger in 2024, with NATO European allies’ defense expenditure expected to rise to meet the alliance’s agreed 2% of gross domestic product. That is a significant increase from 1.47% 10 years earlier in 2014.

Defence Expenditure as Percentage of GDP NATO Total and NATO Europe

The Morality of Investing

The sea change has led to a substantial rise in the share prices of defense stocks, as illustrated by a rise of approximately 50% in the price of the VanEck Defense UCITS ETF since its launch in March 2023. What’s more, it has also been accompanied by a softening in attitudes about the morality of investing in defense stocks. It should be noted that past performance does not guarantee future returns and investors in the VanEck Defense UCITS ETF run the risk of capital loss, equity market risk and sector concentration risk.

Nowhere has the mentioned softening of attitude been clearer than in a joint statement from Britain’s finance ministry and the UK asset management body, the Investment Association. “Investing in defense companies contributes to our national security, defends the civil liberties we all enjoy, while delivering long-term returns for pension funds and retail investors,” it said.

This goes against the previous environmental, social and governance (ESG) concept, which held that any company making weapons was bad and should not be invested in. However, times are changing and so it seems are some people’s views.

That said, some big institutional investors such as pension funds remain reluctant to invest in defense. That may be due to concerns about breaching regulations as to what constitutes being “sustainable” under European Union regulations as well as worries about their reputation.

“If politicians are to succeed in raising much more capital from private investors, further targeted measures will probably be needed in the EU and Denmark to create a greater acceptance of and understanding of the investments,” Thomas Vile Jensen, deputy director of Insurance & Pension Denmark, was quoted as saying in IPE.com recently.²

Shades of Grey

Certainly, the military is now lobbying pension funds. “The ESG goals were never intended to stop us from defending ourselves. I don’t know what’s unethical about self-defense,” opined Rob Bauer, chairman of the military committee, NATO, at the IVP Institute for Pension Education 2024 spring seminar on pension funds.

Politicians and the military alike are eager to free up investment capital to invest in expanding Europe’s defense industrial base, in case the continent needs to defend itself at some point and to deter aggression. What’s more, they recognize that more investment in defense company stocks effectively reduces their cost of capital.

Evidently, the debate about whether defense companies could be considered ethical investments – or at least not unethical – is changing. For some the matter may remain black and white: companies that make weapons for killing will never be acceptable investments. For others, though, there are shades of grey and it looks like defense stocks are likely to become increasingly sustainable.