Can defence stocks be ESG Can defence stocks be ESG Can defence stocks be ESG

Can defence stocks be ESG

Ida Kassa Johannesen

Head of ESG investments, Saxo Bank.

Summary:  Traditionally ESG investors have excluded defence stocks from their portfolios due to ethical concerns over defence companies' association with warfare. Despite impressive performance amid rising global defence spending, the inclusion of defence stocks in ESG portfolios remains controversial, balancing investment ethics with national security interests.

ESG investing, also known as responsible or sustainable investing, is about considering environmental, social and governance factors when making investment decisions. In addition to financial considerations, ESG investors consider the impact that their investments have on the environment and society. Sectors or companies that are viewed as detrimental to the environment or society are typically shunned by ESG investors.

The ESG perspective on defence stocks 

The traditional view of defence stocks by ESG investors has been negative. Defence companies produce weapons and are thus associated with war and death. ESG investors view these companies as non-ESG and choose to exclude them from their investment universe and their portfolios. The exclusion is based on ethical considerations from investors who do not want their investments to support companies that harm civilians and destroy lives. Consequently, defence companies but also oil & gas, mining and tobacco companies have for many years been under-invested compared to technology and healthcare companies that are viewed as more ESG-friendly.

    What are defence stocks

    Defence stocks are many things. Some companies are engaged in the production of ammunition, missiles, and bombs while others are more into (cyber) security solutions, surveillance radars or defence. Some companies continue to produce banned weapons such as anti-personnel mines though most do not. Some companies don’t mind dealing with dictatorships while others avoid it at all costs. 

    Saxo’s Defence theme basket include names like RTX (former Raytheon), Lockheed Martin, Northrop Grumman, Boeing and Rolls-Royce. RTX is known for being one of America’s prime defence contractors while Boeing is known for its commercial airplanes segment. Defence companies tend to perform poorly ESG-wise due to their association with human rights abuse and violations, pollution and lack of transparency and accountability. Indeed, out of the 19 companies in Saxo’s Defence basket, only Hensoldt has top ESG risk rating, all the others have average or below average ratings and as such would not be considered ESG stocks

    Impressive performance

    For years, defence stocks and in particular European defence companies were cheap and traded at hefty discounts. Russia’s attack of Ukraine in Feb 2022 changed this dynamic and Defence spending increased significantly. According to the International Institute, global defence spending has reached record levels not seen since the cold war, USD 2.2 trillion in 2023. In Europe alone, spending topped USD 388 billion in 2023 and in the UK spending will reach USD 108 billion by 2030 or 2.5% of GDP. This growth in defence spending has helped boost the revenues and stock prices of defence companies. Saxo’s Defence stock basket performance in 2023 was 33.2% including reinvestment of dividends while the MSCI World Index in USD was up 23.8%. Since inception on 31 December 2015 the defence basket is up 257% compared to 139% for the MSCI World Index. 

    To exclude or not to exclude?

    It is a given, defence companies produce weapons that make it possible for wars to be waged and innocent lives to be taken but that is not the full story. Defence companies are also in the business of providing defence and protection and they help maintain sustainable peace.

    Let's think about it for a minute, where would Ukraine be today without weapons? Without its effective Iron Dome air defence system, what would Israel look like after Iran’s last 300 drones and missile attack? The reality is, that defence is also a matter of national security and defence companies and their weaponry and artillery also serve as a deterrent in today’s world where unfortunately diplomacy does not always work. 

    As evidenced by Sustainalytics assessment of Hensoldt, defence stocks can have top ESG ratings, defence stocks can be ESG. So, does it make sense to exclude all defence stocks from ESG portfolios? Well, there is no easy answer. Ultimately whether one chooses to exclude defence stocks or not is a matter of opinion. But, whatever the choice, it is important to remember not to demonize defence companies and those who choose to invest in those companies, even the ones that produce weapons. After all, we all enjoy the protection and safety that those same weapons afford.

    As the George Orwell attributed quote says: “People sleep peacefully in their beds at night only because rough men stand ready to do violence on their behalf.  

    How to invest in Defence stocks

    You can browse through Saxo’s Defence theme for a list of companies that provide a relatively pure exposure to increased defence spending. Note that unlike our typical ESG themes, the Defence theme does not only include companies with top ESG ratings.

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