ESG funds worth billions poised to rise on defence stock rally as Hamas-Israel conflict rages

Shares in defence giant Lockheed Martin have jumped 9% from market close on 6 October, while BAE Systems — the UK’s biggest defence contractor — saw its shares climb 5% while its London-listed peer Babcock racked up gains of 2% by the end of 10 October.

Europe’s defence firms also saw their shares pep up, with Rheinmetall up 9%  and Italian security firm Leonardo up around 7% at the time of writing.

Hundreds of sustainable funds are poised to ride this wave. Data from Morningstar, compiled for Financial News, show green funds in the UK and Europe have an estimated £4.2bn of investments held in the aerospace and defence sector.

While ESG funds have tended to avoid pumping money into weapons manufacturers on ethical grounds, recent military conflicts, including the war in Ukraine, have sparked a heated debate about whether there is a place for these companies in green portfolios.

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Just over 50 UK sustainable funds have positions in aerospace and defence firms, according to Morningstar, while 748 funds in Europe have exposure to the sector.

This covers companies that manufacture products, including aircraft and aircraft parts, tanks guided missiles, space vehicles, ships and marine equipment, as well as businesses that provide repair and maintenance services.

VanEck Space Innovators Ucits ETF has the biggest exposure among the green funds in Europe, with a 36% weighting to the sector, followed by Quadridge France Smallcaps with 15% held in these stocks.

Other European funds with exposure include the TCW Global Premier Sustainable Equities fund (11.3%), the Veritas Global Focus fund (11.2%) and the Veritas Global Real Return fund (10.9%).

A VanEck spokesperson said that “the fund has profited from the jump in defence stocks caused by recent events in the Gaza region”.

But they added it is not the aim of the ETF to invest in weapons manufacturers, noting its avoidance of Lockheed Martin and Boeing. Controversial weapons, such as mines and chemical weapons, and civilian weapons and ammunition are excluded using an ESG screen.

“Although the space and weapons manufacturing industries are very much entangled, the VanEck Space Innovators Ucits ETF aims to provide as much of a pure play investment into the global space industry as possible,” the spokesperson said, citing Virgin Galactic as an example.

Veritas, TCW and Inocap were contacted for comment.

The UK sustainable funds with the biggest weighting to the sector, include a trio of funds from Royal London Asset Management – the Royal London Europe ex UK Equity Tilt fund (2.5%), Royal London UK Core Equity Tilt fund (2.4%) and Royal London UK Broad Equity Tilt fund (2.3%).

Royal London UK Core Equity Tilt had the most money tied up in aerospace and defence firms, with investments totalling £137.7m, according to Morningstar estimates. The BlackRock ACS World Low Carbon Equity Tracker was behind it, with £97.7m invested, followed by the BlackRock ACS World ESG Equity Tracker with holdings worth £81.6m.

An RLAM spokesperson said the funds, which are part of its range of passive alternatives, have “specified, aggregate climate targets but do not have a sustainable investment as an objective”.

“Given the funds’ objectives to deliver capital growth and income by investing typically 90% of assets in the relevant index, there will be relatively close to benchmark weight in aerospace and defence and, indeed, any other sector,” they said.

Meanwhile, the Artemis SmartGARP Paris-Aligned Global Equity fund, AllianceBernstein Sustainable US Equity fund and AllianceBernstein Global Equity fund also play in this space, according to the Morningstar data, with holdings ranging from 1.8% to 2.2%.

Peter Saacke, who manages the £19.9m Artemis fund, told FN it has a focus on climate change so defence companies are not excluded from the investible universe by default. Saacke invests in BAE Systems and until recently owned Qinetiq, a Hampshire-based defence tech company.

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“Sadly, the invasion of the Ukraine and the atrocities in Israel show that having a defence industry is necessary, whether we like it or not,” he said.

The AllianceBernstein funds’ holding is in Hexcel, which manufactures carbon fiber and composite materials used to build light-weight airplanes, according to a person familiar with the matter.

AllianceBernstein does not invest in manufacturers of controversial weapons and firearms, as well as companies deriving more than 5% of their revenues from selling weapon systems and/or essential, tailor-made weapon-related products or services to the military or defence industry, they added.

Most of Hexcel’s sales are to Airbus and Boeing for commercial craft but a small percentage of its revenues are derived from the defence industry.

ESG banner on defence stocks

Although the case for sustainable funds owning defence stocks used to be cut and dry, Russia’s invasion of Ukraine has swayed some minds in the City about including weapons manufacturers under the ESG banner.

Newton Investment Management boss Euan Munro was among those to make an ESG case for defence stocks, telling FN that national security is part of a “common good” and it’s better for them to be in the hands of responsible shareholders who will hold companies to account.

A decent proportion of FN readers would seem to agree, with 44% saying there is a place for guns in green portfolios, more than the 41% who opposed the idea, in a survey ahead of COP27 last year.

But other investors were less sure the potential benefits outweighed the very serious risks.

Amanda Young, Abrdn’s chief sustainability officer, told FN last year that while she is “entirely supportive of every nation having the right to defend itself… there are massive implications for the use of weapons on civilians”.

“Until there are clear inabilities for weapons to be transferred to less democratic states, weapons cannot be considered pro-ESG,” she said.

To contact the author of this story with feedback or news, email Kristen McGachey