When thinking about the top funds and stocks to invest in, defence is a sector that many investors have avoided historically based on environmental, social and governance (ESG) concerns.
However, ever since Russia’s invasion of Ukraine, there has been a shift in attitudes with many starting to believe that strength among Britain and its European allies is essential to securing and maintaining peace in the face of Russian aggression.
Developments in recent days have brought concerns about European security to a head, with significant implications for defence spending.
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UK defence stocks like BAE Systems, Rolls-Royce and Babcock International have all risen as a result, as investors anticipate greater investment in national security. At the time of writing, BAE Systems is up almost 12% over the past five days, and Rolls-Royce and Babcock are up almost 4%.
The same is true in continental Europe. German automotive and arms manufacturer Rheinmetall is up more than 30% over the past five days, while French aerospace and defence company Thales is up more than 12%.
America’s retreat: what has happened in recent days?
Events have taken a worrying turn over the past week. Last Wednesday (12 February), US president Donald Trump spoke to Russian president Vladimir Putin without consulting European leaders, effectively bringing Putin in from the cold.
Trump has since sent US officials to speak with Russian representatives in Saudi Arabia – so-called “peace talks” that Ukrainian president Volodymyr Zelenskyy was not invited to.
Separately, last Friday (14 February), vice president JD Vance delivered a humiliating speech at the Munich Security Conference, telling Europe it needed to “step up in a big way to provide for its own defence”.
The more than subtle implication was that the US is serious about its new policy of isolationism. This is a marked shift in direction. Since the end of the Second World War, the US has been a reliable ally in helping to maintain peace in Europe.
In response, European leaders scrambled to attend a summit in Paris on Monday (17 February). By starting talks in Paris, the hope is that Europe will be able to put its differences aside and come to an agreement on how to bolster European security and support a peace deal in Ukraine – crucially, a deal that involves and is acceptable to Ukraine rather than one brokered between Trump and Putin.
Defence spending has been a big focus. If the US cannot be relied upon to come to Europe’s aid, then European nations will need to increase their spending significantly.
UK prime minister Keir Starmer has even said he would be willing to put UK peacekeeping troops on the ground in Ukraine if necessary, calling the current moment a “generational challenge” for UK security.
Outlook for the sector – should you invest in defence stocks?
All of these developments point in one direction – increased defence spending.
Currently, NATO requires all member states to spend 2% of GDP on defence each year, although recent reports suggest it could be considering upping this to 3% per year by 2030. Trump has called on NATO members to spend even more, arguing for 5%.
“Already, EU president Ursula von der Leyen has proposed that defence be exempted from EU limits on government spending – and the UK may need to follow suit,” said Hector McNeil, co-chief executive at HANetf, a provider of exchange-traded funds.
“Keir Starmer had previously pledged to increase defence spending to 2.5% of GDP, which has not yet materialised, but this now seems like it could be the bare minimum,” he added. Provisional figures suggest the UK spent 2.3% in 2024.
Defence stocks are likely to continue to rise over the longer term as a result of any spending increases. This has been the trend since 2022, when European security became a renewed focus after Putin’s invasion.
For those considering the sector, the UK has big players like BAE Systems, Rolls-Royce and Babcock International. However, Jason Hollands, managing director at investment platform Bestinvest, says investors would be better taking a global approach.
He explains that the biggest names globally are US firms, such as Lockheed Martin, Raytheon, Northrop Grumman, and General Dynamics.
Explaining the benefits of a global investment approach, Hollands says: “The high-tech nature of modern armaments means multiple firms can be involved in producing fighter jets, missiles, and warships, so defence projects are highly inter-related and typically benefit multiple firms rather than single suppliers.
“Governments also purchase equipment from global suppliers too and do not narrowly restrict themselves to domestically-based firms. For example, the UK’s most advanced fighters currently are the F35-B, whose main contractor is US firm Lockheed Martin, but with components made by both UK-listed BAE and Rolls-Royce.”
Hollands believes that, as part of the negotiations on US-EU trade tariffs and Ukraine, EU countries could actually end up committing to buying more US equipment, which could boost US share prices.
One caveat he makes when talking about the sector more widely is that higher defence spending has already been factored into the valuations of many of these companies, meaning the current landscape is “certainly not bargain-hunting territory”.
For those looking to add the theme to their portfolio, one route is to invest directly in the shares of leading defence companies. Hollands points out that shares in Rolls-Royce have risen by 89% over the past 12-months, generating a better return than six out of the seven “Magnificent Seven” tech stocks.
Alternatively, an ETF will allow investors to track the sector more broadly. “The Future of Defence UCITS ETF (by HanETF) provides exposure to a basket of 60 shares from defence and cybersecurity companies that derive the majority of their revenues from NATO member countries or NATO allied countries,” Hollands explains.
