If this past couple of weeks has taught us anything it’s that when it comes to security and defence DEI and ESG has to take second place.
For too many years global investors have had to contend with these well-intentioned but hopelessly naïve investment guidelines that actively encouraged cash to flow in the opposite direction to companies where the core business was building the hardware, as well as software to help underpin freedom and democracy.
We don’t have to go back very far in history to understand this, and yet it is only in the past few years that the penny finally appears to have dropped that while the label “ethical investing” sounds all very nice and cuddly, and makes some investors feel good about themselves, the cold hard facts remain that a strong military capability is the best defence, when it comes to deterring hostile actors.
This shift in thinking with respect to defence and ESG had been shifting in recent years and only became even more apparent when Russian tanks rolled into Ukraine 3 years ago, underlining the fact that when it comes to defence, we should either consign ESG to the scrap heap, or redesign the framework as to what ESG is supposed to stand for.
The election of Donald Trump as US President for the second time has changed the narrative around defence, and appears to have called time on the belief that we can contract out our defence obligations to the United States as we have done for the last few decades.
There might be some who believe that the US attitude towards this might change in 4 years’ time given that Trump can’t run again, however that comes across as wishful thinking given his vice President JD Vance appears to be of a similar mind, and is in pole position to be his replacement in 2028.
This means that the UK, as well as Europe will need to up its game when it comes to its own defence spending at the risk of their own future security, whether that be internal or external.
Defence has been an area of the investment market that has been overlooked in recent years due to a reluctance of fund managers to contravene ESG policies, or variations on them due to concerns that investing in them might be considered as unethical, for example the likes of big oil, or tobacco companies is one area that pressure has been brought to bear for investors to avoid.
This is of course nonsense given that freedom and democracy is dependent on strength and deterrence, as anyone with any knowledge of history can tell you.
Consequently, this has meant that weapons and defence manufacturers have often found themselves overlooked or underinvested due to pressure, imagined or otherwise from activist investors to avoid certain sectors to reinforce the idea of ethical investing.
Given the continued uncertain geo-political climate, the Russian invasion of Ukraine, China’s ambitions towards Taiwan, as well as the instability in the Middle East, the areas of defence as well as internal and external security are only likely to become more important as the decade goes on.
While politicians here in the UK and Europe fixate on “net zero” they seem blind to the idea that defence is set to become even more important, and likely to become more of a priority.
This shift towards defence is no better illustrated than in the performance in BAE Systems share price since Russian tanks rolled over the Ukrainian border, where the share price has more than doubled since breaking above 600p in February 2022.
However, while BAE Systems has performed well, the rest of the sector hasn’t, which suggests some scope for catchup in other areas of the defence sector.
Formerly British Aerospace, this UK company is a key player in the US, as well as UK when it comes to the manufacture of land, sea and air defence, from support services, to weapons systems and munitions, to surveillance and electronic warfare, as well as flight and engine control systems.
The company provides munitions, torpedos, radars, artillery systems and missile launchers, as well as manufacturing Armoured Multipurpose Vehicles for the US army.
In Germany we’ve seen similar strong gains in the share price of Rheinmetall which saw it enter the DAX in March 2023, and is a key supplier of arms and hardware for all branches of the armed forces across Europe.
Back here in the UK, Rolls-Royce shares have also seen an upward pop to new record highs, and while their main business is in civil aviation the company also provides support to the military complex, supplying the vertical lift system for the F35 fighter jet, as well being a major military contractor for the new Eurofighter project, supplying the EJ200 engine for the Typhoon.
Its naval division also builds and designs the nuclear reactors for the Astute and Dreadnought UK submarine program, as well as front line support for the Royal Navy, building and designing gas turbines, diesel engines as well as electrical control systems. It also manufactures the propellers for 95% of the US Navy surface fleet.
The expertise in nuclear has been used to good effect in the design of SMR reactors, an area the UK government seems rather puzzlingly slow to use but has nonetheless secured its first contract in the Czech Republic.
There are also a number of less well-known household names in the UK defence sector that offer valuable services when it comes to defence and security, and where the share price performance hasn’t garnered the same amount of headlines.
Starting with Babcock International, this company has expertise in nuclear, aviation and land, in both civil as well as military, providing maintenance services for the UK’s nuclear submarine fleet, as well as the surface fleet at Clyde and Devonport shipyards.
The company also provides support to the RAF through its HADES programme which includes aircraft maintenance, general engineering and training support at 16 RAF stations across the UK.
QinetiQ has also seen a jump in its share price and is a lesser known but no less important part of the defence landscape for the UK as well as US military. The company is an expert in the field of (UAV) unmanned air land and sea reconnaissance services/drones. They also provide the systems that aid the landing of US aircraft on their Nimitz and Ford class aircraft carriers.
Their expertise also crosses in aviation in the form weapons integration and evaluation on defensive and offensive weapons systems on fast jet, rotary and transport aircraft.
QinetiQ is also helping to develop weapons systems like the new DragonFire laser which the Royal Navy hopes to use on its ships from 2027 to shoot down drones and missiles
Chemring is another important UK engineering company, providing services to the aerospace, defence and security market and whose key strength is in designing sensors and detection, as well as countermeasures (chaff) to protect aircraft and ships from missiles.
These products cover the range of electronic warfare, as well as explosive hazard protection (IED) as well as chemical and biological detection.
The company also provides systems like oxygen mask deployment on commercial aircraft, as well as ejector seat technology for aircrew. Customers range from governments as well as NASA and SpaceX.
As with any investment idea there are no guarantees when it comes to future returns, however when one looks at the way the world is now, it’s quite likely that the services these companies provide are likely to continue to be well sought after, and as such are probably worth a look when it comes to any investment portfolio.
