As geopolitical tensions escalate, professionals are examining the implications of newly launched defence-linked ETFs for investors prioritising ethical considerations in their portfolios.
This week, Global X and Betashares launched their respective defence-linked ETFs. Global X’s ETF (ASX: DTEC) focuses on emerging technologies in modern warfare, while Betashares’ offering (ASX: ARMR) encompasses a portfolio of up to 60 companies deriving over 50 per cent of their revenue from the defence sector.
Notably, VanEck was the first to enter this space with its own defence ETF (ASX: DFND) in September, highlighting the increasing significance of the sector amid global instability. But despite investor interest, it’s believed that some remain hesitant due to potential conflicts with their ESG values.
Estelle Parker, co-chief executive of the Responsible Investment Association Australasia (RIAA), pointed out that while 55 per cent of Australians prefer to avoid investments in weapons, ethical investing is nuanced.
“Investing responsibly and ethically means different things to different people,” Parker said.
“Some may want to avoid investing in controversial weapons like land mines or cluster munitions, but for them, weapons used in the defence of countries such as Ukraine may be acceptable, while others may want to avoid weapons altogether.”
The rise in defence ETFs correlates with global military spending, which surged by 7 per cent to US$2.43 trillion in 2023 – the highest increase since 2009 – and could reach US$3.1 trillion by 2030, according to the Stockholm International Peace Research Institute (SIPRI).
Amid this interest, Parker emphasised the soaring demand for ethical financial products, noting that 88 per cent of Australians expect their investments to be responsible and ethical, up from 83 per cent in 2022.
“In fact, 65 per cent would invest more if their investments made a positive impact in the world. In addition, the growth of global financial flows into ESG and sustainable investments over the long-term is a clear signal that the movement is not waning but evolving,” Parker said.
As such, she stressed that, “now more than ever before, retail investors and consumers need to work with their advisers and funds to scrutinise their investments for alignment with their values”.
Parker also urged fund managers offering defence ETFs to “clearly and consistently communicate” the criteria they employ, including materiality thresholds and types of weapons included or excluded, while providing transparent methodologies and assumptions.
This clarity, she said, enables investors to make informed choices.
But regardless of the strategy used, Parker said “all financial institutions must manage human rights risk preventatively”.
Hugh Harley, former PwC financial services leader and professor at the University of Sydney, agreed that geopolitical tensions have been driving increased defence spending, and hence increased investment interest in this industry.
He told InvestorDaily that, from a shareholder return perspective, defence investments have “a lot of favourable characteristics”.
These factors include a strong demand outlook as governments pursue rearmament, advantageous positions held by key industry players dominating the market and rising competitive tensions among national governments.
“On the other hand, there are many graft, corruption and reputation risks across supply chains [as well],” Harley said.
Ultimately, he noted that ESG in defence investments has varied ethical implications, emphasising that governance is crucial.
“In particular, precisely because of the supply chain and reputation risks in defence industries, the governance dimension becomes absolutely paramount for any skilled investor,” Harley said.
“By definition, risk management goes to the heart of this category of investment,” he said. “Only time will tell if the returns commensurate with the risks.”
Harley also warned that the gradual disintegration of global frameworks will likely hinder cooperative ESG efforts.
“The headwinds we are seeing for ESG as an overall category share the same root cause as the increase in defence investments – rising geopolitical tensions and the fragmentation of post-WW2 global institutions and norms,” he said.
“It is hard to see this being reversed any time soon.”
