In the days and weeks that followed Russia’s invasion of Ukraine, a great many assumptions were put to the sword. Major warfare had returned to the ‘peaceful’ continent of Europe for the first time since 1945; German defence spending has been hiked, and Francis Fukuyama’s prediction of the end of history turned out to be just another chapter after all.
For investors and wealth managers Vladimir Putin’s ‘special military operation’ in Ukraine has thrown up another pressing question: can the defence sector, seen by many as sitting with alcohol, tobacco, oil and coal in the financial sin bin, even be regarded ESG – that is compliant with environmental, social and governance-related investor priorities – given its importance to self-determination?
Well, as ever with ESG, the truth is more nuanced. Many ESG funds already do indeed include defence firms. Morningstar Direct estimates that 44% of sustainably-themed funds have some exposure to the defence sector – compared to about 60% of standard funds, while just 23% of sustainably themed funds actively exclude defence.
Among those that had excluded defence was the Nordic bank SEB, which announced in March that it was updating its ‘sustainability policy’ with the result that six of its funds would henceforth be permitted to include defence equities and bonds in their portfolios, though not of entities involved in nuclear weapons or illegal weaponry such as cluster munitions or land mines.
SEB and media speculation aside, however, seasoned markets watcher Russ Mould, investment director at broker AJ Bell, sees no evidence yet of ESG funds generally rewriting their criteria to embrace defence firms.
That said he’s quick to point to the price rises among defence stocks such as BAE Systems, the London-listed defence giant behind the Typhoon, Type 26 frigate and much more, as evidence of a major shift in market sentiment. (BAE has seen its share price rise from £600.80 on 23 February to £7.62 in early May.)
“In some cases, there’s a clear reassessment of energy security and national security as important cornerstones for society,” says Mould. “Look at how many moved rapidly to shut down Russian operations and the opprobrium that was brought upon those that were much slower.”
There’s also a reassessment about the best way to leverage the control that investors have when it comes to sustainability, says Mould. He notes, for instance, the unintended consequences of mining international Anglo American’s move to divest itself of its coal-making subsidiary, Thungela Resources. The fully independent Thungela has gone on the front foot, its boss declaring, “coal is here to stay”. Moreover, it has seen its valuation soar because of the Ukraine crisis. “Several fund managers have said, you know what, we had more say when we owned the shares than if we just washed our hands of it and walked away. You are beginning to see some refinement of views there.”
As a result, Mould believes that Ukraine will be provoking some to rethink sustainability, and defence included – not least when coupled with buoyant market performance, as both the war continues and countries such as Germany announce significant rises in national defence budget. Does he see the general definition of ESG being flexed to include some defence?
“It’s a trend to watch,” Mould says. “There is always the potential for Wall Street to redevelop the narrative, either to suit its purposes to sell products or because that’s what people think is appropriate.”
That shift in the zeitgeist is something that geopolitics analyst Tina Fordham, formerly the chief global political analyst for 16 years at Citi, is clear-sighted on. “If the world is on fire, then there’s no ESG and there’s no investing at all,” Fordham says. “It’s about time that investors, in general, appreciated the role of defence and security in ensuring democracy and commerce and capitalism and all of the things we believe in.”
An advisor to financial institutions and professional services companies, Fordham confirms that this is a topic that industry figures are discussing considering the war. Does she believe, for instance, that there should be a difference between ‘good’ and ‘bad’ defence companies, perhaps based on whom they sell to and the kinds of weapons they make?
“I think there should be. I’m advocating in my own space that we are much more thoughtful about corruption and kleptocracy, for example.” Fordham also points to the United Nations 2030 17 Sustainable Development Goals (SDGs) – the 16th calls for “peace, justice and strong institutions”. “If companies have a screen that’s looking at supporting the SDGs, it’s possible to think about defence stocks in that respect. As with everything in the ESG world we need to be thoughtful about how we assess these companies and their performance so that we don’t do the equivalent of defence-washing.”
The notion of ‘good’ versus ‘bad’ defence companies finds little favour over at Tribe Impact Capital, a sustainability-oriented wealth manager founded in 2015, where all investments are aligned to the UN’s 17 SDGs. “We invest in things that stop wars happening in the first place,” says Amy Clarke, chief impact officer and co-founder, who discounts the notion that defence investment can ever be regarded as sustainable. “None of [my clients] want exposure to defence because these are impact investors; they’re trying to create communities and a society where everybody thrives and for them, defence isn’t part of that. Defence is the culmination of where government, business and society have failed.” At best she regards defence as a necessary evil
Instead of putting money into guns – and making a morally questionable financial return on them – Clarke believes in investing to meet the underlying causes of conflict. Rather than relabelling defence as ESG or good, she invites investors to consider how Russia is bankrolling its war in the first place: “It’s come from oil and gas, so if you are invested in oil and gas there’s a long hard conversation you need to have with yourself right now around whether you’re still happy with that exposure.”
It’s a valid point but does it entirely obviate the broader question of the sustainability of defence? Perhaps, but perhaps not. As Tina Fordham suggests, to be sustainable, democracies need to be able to defend themselves from aggressors. After all, one thing we all know is that ESG is certainly not a three-letter acronym that’s foremost in Vladimir Putin’s mind.