Asset Managers Churn Out Defense Funds Once Deemed Uninvestable

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(Bloomberg) — As governments across Europe ratchet up defense spending, money managers who previously judged the sector too controversial to touch are taking note.

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There’s currently a proliferation of portfolios focused on defense assets, with fund tickers such as WAR and NATO doing the rounds. Data compiled by Bloomberg shows the number of defense-themed funds doubled last year to a record 47, following decades during which such products — if they existed at all — were only to be found in the single digits. Data through mid-February indicates the current pace isn’t letting up.

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And in a sign of the times, even investors focused on environmental, social and governance (ESG) metrics are now softening once strict exclusion policies to make room for defense assets. 

Mia Thulstrup Gedbjerg, who co-heads the defense industry unit at the Danish law firm Kromann Reumert, said it’s as if “D is the new addition to ESG.”

Europe is now racing to respond to the reset in trans-Atlantic relations triggered by President Donald Trump’s return to the White House. Across the bloc, governments are planning major increases to defense spending and discussing new funding models to pay for it.

For investors, the issue of regional security, combined with the likelihood of big returns, is hard to ignore.

“A lot of capital is going to flow into these companies,” Gedbjerg said.

Roel Houwer, senior product manager at VanEck Asset Management, said public opinion around the appropriateness of holding defense stocks is “changing quite a bit.” His firm launched the VanEck Defense UCITS ETF (Ticker: DFNS) in early 2023. It now has well over $2 billion in managed assets, after returning 44% in 2024 alone. So far this year, it’s up 10%.

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“We’ve seen tremendous growth,” he said in an interview. And flows into the fund in the first weeks of this year “are even bigger than they were in 2024,” he said. The fund draws between $20 million and $30 million of new money each day, he said.

Bloomberg Economics calculates that protecting Ukraine and expanding their own militaries could cost Europe’s major powers an additional $3.1 trillion over the next 10 years. That follows decades of underinvestment, according to a review of EU competitiveness published in September by former Italian Prime Minister and European Central Bank President Mario Draghi.

Europe must make its defense industry more attractive to investors, the Draghi report said. That includes adapting the bloc’s sustainable finance framework to support investments in the industry. 

European Union leaders are now discussing joint financing, and EU Commission President Ursula von der Leyen is due to present a comprehensive plan next month that’s set to include incentives for investors. 

ESG fund managers that add exposure to the defense sector face considerably better returns than they’ve been able to generate by holding traditional green stocks such as wind and solar. 

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The S&P Global 1200 Aerospace & Defense Index rose 17% last year and is up 6% so far this year. The S&P Global Clean Energy Transition Index, meanwhile, is little changed this year, after losing 27% in 2024. 

Rheinmetall AG, which produces tanks and ammunition, is currently held in about 650 ESG funds, according to data compiled by Bloomberg. Lockheed Martin Corp., known for its fighter jets and missile systems, sits in roughly 370 ESG funds. BAE Systems Plc, which produces ammunition, missile launchers and Howitzers, is held in more than 450 ESG funds, the data show.

Defense stocks have outperformed both other industrial stocks and the MSCI World Index, particularly in the past three years, said Kiran Aziz, head of responsible investments at Norwegian pension fund KLP. Only technology stocks have been able to “partially match the return of defense stocks,” she said.

Setting clear rules to let fund managers define stocks and bonds issued by defense companies as sustainable assets may unleash vastly more in investor allocations. There are currently about $14 trillion of fund assets reporting under the EU’s Sustainable Finance Disclosure Regulation, according to Bloomberg Intelligence. 

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Last year also saw a shift in money managers’ willingness to hold the most extreme weapons of war. Analysts at Barclays Plc said in a recent note that conventional funds launched last year warmed to controversial weapons, with only 23% excluding the category. 

The thaw in investor perceptions around defense assets may bring with it considerable reputational risk, however, because investors can’t rule out the possibility that weapons funded through their capital allocations end up in the wrong hands. 

Aziz says KLP excludes controversial weapons — a category that encompasses cluster munitions, chemical weapons and anti-personnel mines — because they “fail to distinguish between military and civilian targets.” Aerospace and defense companies currently make up 1.4% of shares held by KLP, compared with less than 1% in December 2019, Aziz said. 

“This is an industry that requires extra care precisely because it is a sector that is complex where new technology is constantly being developed with little transparency,” Aziz said. “In addition, many different players in the sector have varying levels of regulation and control.”

Loredana Muharremi, an analyst at Morningstar Inc., says the fund industry is now waiting for clearer guidance from regulators in Europe. 

Clarifications “would support greater investment in these areas,” she said.

—With assistance from Akiko Itano.

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