Are defence stocks an ESG asset now?
A combination of Donald Trump’s pestering and nervousness about America’s reliability as an ally - including concern Greenland might follow the fate of Venezuela - has prompted European nations to increase the amount they spend on defence. Does that mean asset owners view defence as an attractive investment opportunity? And could it even be defined as an ESG asset? (Rodger Mallison/Fort Worth Star-Telegram/TNS)
2025 was a whirlwind for markets following the return of Donald Trump as US president.
But as we have seen in recent days it is not just the markets which have seen some degree of turmoil, it is geopolitics too.
But a combination of Trump’s pestering and nervousness about America’s reliability as an ally - including concern that Greenland might follow the fate of Venezuela - has prompted European nations to increase the amount they spend on defence.
Last year the UK announced its Nato spending would double by 2035 reaching 5 per cent of GDP. In 2024, the UK’s expenditure on Nato stood at 2.3 per cent of GDP, equivalent to $84.2bn.
Rathbones’ defence equity analyst Claire Titmarsh says the rise in defence budgets and the push for strategic autonomy has led to a valuation re-rating among European defence stocks which have experienced strong share price performance.
“The perceived cooling of US support for Ukraine under Trump has reinforced Europe’s need for self-reliance in defence, accelerating investment in domestic capabilities. This dynamic has contributed to a regional shift, with European defence names outperforming the US as investors anticipate sustained spending growth across Nato Europe members”, Titmarsh said.
Jean Roche, fund manager of the $332mn Schroder UK Mid Cap fund, described the defence as “a sector that nobody wanted to invest in three or four years ago”.
She added that alongside artificial intelligence, defence became one of the ‘hot teams’ because “investors are always looking for growth”.
“The way to see defence stocks is actually inexpensive technology stocks because there's so much technology in defence,” Roche said, adding that the sector can also act as an inexpensive industrial play as well.
This had us wondering at AOX whether institutional investors were looking to capitalise on the increased government spending on defence.
Karen Shackleton, founder at Pensions for Purpose and independent adviser to local government pension schemes, says she has seen “increased interest from pension funds around topics such as defence,” highlighting that the 16th UN Sustainable Development Goal is to support peace and justice.
Shackleton said there had been a shift in the perspective of pension funds who initially prioritised other UN SDGs such as renewable energy and climate change.
“There were some very, very common themes. You could almost predict what they're going to say and then suddenly out of nowhere SDG 16 is being talked about and I think that just reflects the sort of geopolitical state of the world,” she said.
For Shackleton SDG 16 is broad and could span other ‘defensive’-type investments giving the examples of cyber security, infrastructure protection and even social housing under the banner of ‘social justice’.
Responsible investing
Now an overriding question for any institutional investor is whether defence investments fit within their environmental, social and governance or responsible investment criteria.
On the face of it Shackleton said that pension funds were more likely to prioritise defence investment over their ESG considerations if the threat of war was more imminent.
“The closer pension funds are to a border where there's war, the more likely they are to be prepared to change their ESG priorities, and they'll say that they will invest in defence stocks, and some of them are saying that they will do that only when those companies are in Nato regions,” she said.
MandateWire records show an uptick in defence equity holdings from other European institutions in countries such as France, Sweden, Denmark and Kosovo.
Shackleton adds that UK pension funds are approaching the space with caution. “They're starting to think about it, but still quite nervous as to the reputation risk that they might have”.
It seems as though UK pension funds aren’t the only ones nervous of their reputation as when AOX approached several of the large investment consultancies such as Mercer, Gallagher (formerly Redington) and Barnett Waddingham for comment on defence investing, all declined, stating defence is not something they would want to speak on.
A change in the zeitgeist?
Last year, signaled a shift amongst one of the UK’s largest institutional investors… its National Wealth Fund, with the Chancellor giving the $37.6bn fund a new strategic steer.
The Chancellor said the NWF should consider investments in dual-use technologies and support supply chain resilience which can “benefit defence and security,” a spokesperson for the NWF told AOX.
The NWF will be open to make investments “in areas vital to defence”, such as mineral supply chains, advanced manufacturing, or emerging and disruptive digital technologies with the purpose to crowd private investment into these sectors.
Other European funds that are labelled as ‘sustainable’ have been increasing their weight to aerospace and defence. As at Q3 2025, the combined average weighting among active and passive European sustainable funds was 2.1 per cent, an almost fourfold increase from Q4 2021 where average weighting was around 0.5 per cent, according to Morningstar data.
Elsewhere the UK’s largest defined contribution provider, the $67bn National Employment Savings Trust, told AOX that while it holds a portfolio-wide exclusion on companies involved in the sale of controversial weapons, it already invests in the defence universe.
As at September 30 2025, defence made up for 0.5 per cent of Nest’s portfolio, valued at $409mn.
Schroders’ Roche says “the way I see it is whether more spend is going to go into a sector or not,” with the fund still having a slight overweight to defence compared to its benchmark.
She does highlight that when conversations around peace arise, as there are now between Ukraine and Russia, there may be a pullback from investors.
“As soon as there are discussions around peace then investors get nervous. When something's gone up a lot, then people start looking for reasons to have a bit of a Wile e Coyote moment”.
Yet with European governments making larger commitments to defence, Roche concludes “I think it's only going in one direction”.