Since Russia invaded Ukraine in February 2022, debate has ramped up about whether investing in the defence sector can be considered responsible.
The debate has intensified in recent months, as European nations respond to the changing geopolitical position of the US under President Trump.
European defence budgets look set to soar over the coming years, and politicians are trying to tap the private sector for more cash too.
Almost 100 MPs recently signed an open letter urging exclusions-based funds to re-examine their approach to the defence sector, which is commonly excluded alongside industries like tobacco, gambling and alcohol.
At the same time, global tensions continue to flare. Recent cross-border clashes between India and Pakistan have reignited long-standing regional security concerns, highlighting the ongoing need for defence preparedness.
Prime Minister Keir Starmer recently unveiled the Strategic Defence Review, which includes plans to boost nuclear capabilities, increase munitions stockpiles, invest in advanced military tech and create a new cyber command to help counter online threats.
Here’s a look at the pros and cons of investing in the defence sector and some fund ideas – one that will never invest in defence, and one that will invest if a certain set of criteria are met.
This article isn’t personal advice. If you’re not sure an investment is right for you, ask for financial advice. Remember, all investments can rise and fall in value, so you could get back less than you invest.
Why might you consider investing in defence?
One of the primary reasons for investing in the defence industry is to support the country’s ability to defend itself against threats and ensure national security.
It’s impossible to have sustainability without security and stability, and the world is an increasingly uncertain place.
US President Donald Trump has made it clear that Europe can’t rely on American military support if Putin invades the Baltic states, which are NATO members.
European countries have been gradually increasing their defence spending in recent years, spending an average of 2.2% of GDP on defence in 2024.
Countries like Estonia and Latvia, which sit on the Russian border, have committed to spending as much as 5% of GDP on defence.
In the UK, defence spending will increase from 2.3% to 2.5% of GDP by 2027, with an ambition to reach 3% in the next parliament, though there is growing pressure for military investment to rise even further.
A broad increase in defence spending should bode well for European defence companies and could present opportunities for investors.
The defence industry provides significant economic benefits too.
It’s a major source of employment across a diverse array of areas, from manufacturing to training services. It also supports smaller suppliers within local communities, boosting economic growth and stability.
Finally, research and development in the defence sector can lead to significant technological advancements with civilian applications.
For instance, the U.S. Department of Defence started developing the GPS (Global Positioning System) in the 1960s. Today, this technology is embedded in our smartphones and is widely utilised in industries like aviation, shipping, and agriculture.
What are the challenges of investing in defence?
On the other hand, many investors have ethical concerns about the defence industry.
The weapons it produces are designed for combat and can result in devastating consequences. They have the potential to kill and injure both military personnel and civilians.
These weapons can also cause extensive destruction to infrastructure, crippling essential services and facilities. The impact on local communities can be profound, often resulting in displacement and long-term social and economic disruption.
Some would argue that some regimes that violate human rights and commit alleged war crimes are supported by some defence companies.
For example, it’s been alleged that BAE Systems, the UK’s largest defence contractor, has established trading relationships with 13 countries on the UK’s human rights watchlist.
It’s also been alleged that 10 defence companies, including BAE Systems, sold military equipment and weapons to Saudi Arabia which were later used to commit war crimes in Yemen.
BAE Systems is unable to confirm who it trades with, but says it’s committed to upholding ethical standards.
How does HL consider issues around controversial weapons?
Controversial weapons are distinct from traditional weapons. In line with our ESG data provider, Sustainalytics, HL’s definition of controversial weapons includes antipersonnel landmines, cluster munitions, biological and chemical weapons.
These weapons are banned by various international treaties, and cause indiscriminate harm, long-lasting environmental damage, and severe humanitarian consequences.
Companies involved in the production, maintenance, trade, or research and development of controversial weapons, or components considered tailor-made and essential for the lethal use of the weapon, are excluded across many mainstream funds on HL’s platform and generally.
This exclusion also applies to funds managed by our sister company, HL Fund Managers (including the HL Select funds, HL Building Blocks, and HL Portfolio Funds), where the managers have investment discretion.
Defence is an area that HL clients are split over.
Our December 2024 survey revealed that just over a third of HL clients are happy to invest in the defence sector. Another 27% are willing to invest if defence accounts for less than 20% of the company’s revenue.
Fund ideas for those who do want to invest
Whether you want to invest in defence, or avoid the area entirely, there are funds on the Wealth Shortlist that will meet your personal preferences.
Here are two fund ideas – one that will never invest in defence, and one that will invest if a certain set of criteria are met.
Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.
For more details on each fund and its risks, use the links to their factsheets and key investor information.
Want to avoid defence stocks? – Aegon Ethical Equity
Audrey Ryan has managed the Aegon Ethical Equity fund for over 26 years. She aims to identify and understand the key environmental, social and governance risks of each company, industry and sector she invests in.
She believes companies that lead the way in governance and sustainability tend to outperform over the long run.
The fund uses a strict exclusions-based approach.
It won’t invest in companies that generate significant revenues from activities deemed unethical, including tobacco, alcohol and gambling.
Companies that manufacture military armaments, nuclear weapons, or associated strategic products, are also excluded, as well as those producing civilian firearms.
The fund also won’t invest in companies that operate in countries with poor human rights records if they don’t have solid policies to address this issue.
Investors should note the fund’s investments in smaller companies add risk.
Looking to invest in defence stocks? – Liontrust UK Growth
The Liontrust UK Growth fund is co-managed by Anthony Cross, Victoria Stevens and Matthew Tonge, and invests in companies with unique advantages over the competition.
The managers believe the hardest economic advantages to copy are intellectual property, like patents and trademarks, strong distribution channels and significant repeat business.
A company must have at least one of these attributes before it's considered for the fund.
Defence companies aren’t off limits for this fund, and the managers will invest if they feel the company meets their established criteria.
The managers consider the ESG risk associated with every investment, as well as any associated controversies.
BAE Systems is currently among the fund’s largest investments.
The managers believe the company has many competitive advantages, including significant intellectual property and technological leadership, built up through years of heavy investment in research & development.
Like many companies in the defence industry, BAE benefits from a number of long-term contracts, repeat business with government customers and a significant order backlog. This helps provide exceptional visibility on future earnings.
Finally, the company’s global footprint, and involvement in major top-secret initiatives, provides high barriers to entry for competitors.
The managers also say they are comforted by the high standards applied to UK-listed defence companies. For example, they must adhere to high reporting, audit and risk-management standards, as well as strict arms export controls set by the UK government.
While the fund invests in defence companies, there’s a firm-wide commitment not to invest in companies producing controversial weapons.
The fund has the flexibility to invest in smaller companies and derivatives which if used, adds risk. The fund’s relatively high exposure to fossil fuels also increases risk.
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