Can Investments in Defense Stocks Be Sustainable?

The Ukraine war poses a major dilemma for fund managers. Can investments in shares of defense companies and arms manufacturers meet ESG criteria?

In recent years, the debate about which investments are sustainable and which are not has gained significant momentum. So far, the main issue has been how to achieve climate goals, and whether or not the use of gas or nuclear power, for example, as transitional technologies will help in this regard?

However, Russia’s attack on Ukraine has sparked a completely new ESG discussion. “I would worry about the arms industry creeping in through the back door,” said Hendrik du Toit, managing director of Ninety One Asset Management, in an article published by the U.K. industry platform Financial News.

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Role in protecting civilians

Those who rate defense stocks investments as ESG compliant argue that the defense sector plays an important role in protecting civilians as geopolitical tensions rise. “The question now is whether security is a commons that ESG portfolios can and should invest in. In my view, security is a commons,” said Euan Munro, managing director of Newton Investment Management.

“While I fully agree that every nation has the right to defend itself,” said Amanda Young, chief sustainability officer at UK fund manager Abrdn. “But the use of weapons against civilians and the indiscriminate casualties of certain weapons have massive consequences. Until there is a guarantee that weapons will be passed on to less democratic states, they cannot be considered ESG compliant.”

Change of heart among some asset managers

Meanwhile, the European Commission continues to work on a taxonomy for sustainable investments, and arms companies are seeking to be included in that category as well.

Some fund issuers have changed their stance in light of the war in Ukraine. While some exclude only manufacturers of weapons such as cluster bombs, others have weeded out the entire industry.

Swedish group SEB opened up investments in the sector to some of its funds last March, lifting a blanket ban introduced in February 2021.

Defense as a necessity

Even banks have come out in favor of classifying defense stocks as sustainable investments. “Defense is likely to be increasingly viewed as a necessity that facilitates ESG as a business, as well as the maintenance of peace, stability, and other social goods,” reads a Citigroup analyst note.

The note refers to Germany’s planned increase in defense spending. And the country “is unlikely to be the only European nation to increase its defense spending,” it said. “Given recent events, we reiterate our view that the market will reconsider the ESG rating of the defense industry,” the Citi analysts said.

Sticking to restrictions

Asset manager Federated Hermes does not plan to change its approach to defense stocks.

“We have always had, and will continue to have, a firm-wide restriction on companies that derive revenue from the production of weapons prohibited by international law or recognized international conventions,” said Leon Kamhi, head of responsibility. “Any involvement in the production of these weapons or a critical role in their production will result in exclusion.”

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(Featured image by Rohitvarma via Pixabay)

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First published in finews.ch, a third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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