Defence industry investments are not a new segment of the market, however, with growing geopolitical tensions across multiple theatres, a recent report from the Stockholm International Peace Research Institute (SIPRI) indicated that global military spending increased by 7 per cent to US$2.43 trillion in 2023, the largest annual rise since 2009, with projections suggesting it could reach US$3.1 trillion by 2030.
Investment managers have now launched a new wave of exchange-traded funds (ETFs) focused on companies involved in national security, military technology, and defence infrastructure to capitalise on this increased spending.
VanEck was the first cab off the rank, launching a defence ETF (ASX: DFND) in September, with Global X adding its Defence Tech ETF (ASX: DTEC) to Australian shores and providing exposure to cutting-edge technologies driving the future of warfare, including robotics, cyber security systems, and artificial intelligence.
This was followed by Betashares unveiling its Global Defence ETF (ASX: ARMR), which provides access to a portfolio of up to 60 companies that derive more than 50 per cent of their revenue from the defence industry.
According to financial adviser at Northeast Wealth James O’Reilly, while he doesn’t personally support defence investments, it’s important that people are “free to invest as they wish”.
“Those investing in such ETFs have made a conscious decision to do so. More importantly, giving investors more choice encourages conscious decisions,” O’Reilly told ifa.
“Every year, RIAA presents large surveys which indicate there are far more people are interested in responsible investing – but doing nothing – than those taking action. I look forward to a world where everyday investors have their super and investments aligned to their values, and we get there by closing the gap between people’s interest and action, rather than making certain investments inaccessible.”
However, while he is firm that individuals are able to invest in a way that best suits their own beliefs, it’s also important that they have a proper understanding what the end result is from putting their investment dollars in defence.
“I support people having the freedom to invest as they please, but the lines can become very murky when justifying these positions. I disagree with the argument that defence investment dollars are ‘passive’, e.g. going purely toward defending from external attacks,” O’Reilly said.
“When you invest in defence, you accept zero control on how these defence assets will be used in the future. With this view, it’s hard to look past the damage that they facilitate during hostility.”
Are clients concerned?
According to O’Reilly, a number of his firm’s clients have expressed concern over remaining in investments that contain an exposure to military technology – though exiting these positions can be difficult.
“This is becoming a bigger question for many of our members, especially as devastating conflicts develop in Ukraine and the Middle East,” he said.
“The main ethical consideration for our members is the extent to which they want to be divested – especially when the exposure exists within index investments which have served them well in the past. The Nasdaq 100 for instance, includes Honeywell, Microchip Technology and Analog Devices – all of which have strong ties to aerospace and defence.
“Like many advice practices, Northeast has adopted a core-satellite investment philosophy, so trying to eliminate exposure within a low-fee core component can require significant portfolio turnover.”
Another consideration, he said, is how far down the rabbit hole a client wants to go and whether their concerns extend throughout the entire supply chain – a huge number of companies servicing the defence industry are not in the business of arms manufacturing.
“There are many ways to achieve a great return without having [direct] exposure in your portfolio. It becomes more opaque with companies which indirectly profit from defence, for instance a cyber security business whose revenue sources include a relatively small defence contract,” O’Reilly said.
“In this case it can be prudent to investigate the size of that contract relative to the company’s total revenue, and (where possible) the services that are being offered within that contract.”
Ultimately, he explained, advisers should have a “deep understanding” of their clients’ motivations and mindset, including whether they “properly understand the implications of this investment and still feel comfortable”.
“From here, it boils down to ethics and agency,” O’Reilly said.
“If your client has an investment philosophy which doesn’t align to yours, you’re probably not best suited to serve them – nor do they fit well into your practice.
“It’s therefore important that advisers have refined their own ethical boundaries and have the conviction to say ‘no’ when they identify a mismatch with a client.”
Very few advisers I know pay any respect to socially responsible investing, and any mention of it from them tends to be lip service. Advisers that I have spoken to do not know how to have a conversation about it with clients and would rather not have develop a portfolio around their clients’ ESG requirements.
The same goes for product providers.