BlackRock became the third issuer to enter the defence ETF tussle in Europe last week after passing up the opportunity to launch the continent’s first defence sector ETF in 2018.
The iShares Global Aerospace & Defence UCITS ETF (DFND) was granted approval by the Central Bank of Ireland (CBI) in April 2018, however, the world’s largest asset manager opted to hold fire for a further six years.
The decision enabled VanEck to become the first to offer the exposure in Europe via the $164m VanEck Defense UCITS ETF (DFNS) last March. In July, a rival entered the fray in the form of the $84m Future of Defence UCITS ETF (NATO).
DFND launched in February, replicating the S&P Developed BMI Select Aerospace & Defense 35/20 Capped Index INR of 56 developed market aerospace and defence companies involved in civil or military aerospace and defence equipment, parts of products, defence electronics and space equipment.
Constituents are market cap-weighted and must be included within the Global Industry Classification Standard (GICS) Aerospace & Defence sub-industry, must have a minimum market cap of $300m, float-adjusted market cap of $100m and a six-month median daily traded value (MDVT) of $3m.
This differs from DFNS and NATO, which have higher minimum market cap requirements of $1bn apiece and narrower baskets of 28 and 49 constituents, respectively.
The two early movers also offer an entirely different flavour of defence exposure.
DFNS tracks the MVIS Global Defense Industry index, which captures companies deriving at least half of their revenues from defence and aerospace hardware, communications, satellites, security and IT, unmanned aircraft, simulation technology and biometric scanners.
NATO, meanwhile, replicates the EQM Future of Defence index, offering exposure to companies deriving at least 50% of their revenues from manufacturing or developing military aircraft, defence equipment or cyber security services for a NATO+ member country.
Crucially, the VanEck and HANetf ETFs both incorporate some ESG criteria by excluding companies in violation of UN Global Compact principles, meaning their defence exposure skews towards digital defence.
This point is particularly true for DFNS, which screens out companies with involvement in controversial weapons, leading to the notable exclusions of traditional defence players including Lockheed Martin, RTX – formerly Raytheon – and BAE Systems.
Overall, while NATO captures 11 of the top 20 and five of the largest 10 defence companies highlighted by Defense News, DFNS captures just six of the top 20 and none of the top 10.
BlackRock’s DFND, meanwhile, captures seven of the top 10 – with the only omissions being Chinese companies – and 12 of the top 20.
However, this seemingly higher beta defence exposure contains nuance. DFND stands alone in awarding some of its top allocations to the largest, traditional defence companies, including 12.1% to RTX and 8.8% to Lockheed Martin.
On the other hand, it encounters the issue of market cap weighting a basket of companies with revenue exposure to a sector. For instance, it awards top 10 allocations to Airbus – 9.2% – and Safran – 6.1% – with the two companies deriving only 20% and 21% of their revenue from defence sector-related activities in 2023, according to Defense News.
Also, while capturing a larger number of companies, DFND’s practical exposure is more concentrated than its peers, allocating 73.7% to its top 10 constituents versus 62.1% for DFNS and 45.5% for NATO.
Accounting for this higher concentration among its top positions, the BlackRock ETF’s benchmark employs the UCITS 20/35 rule. In the S&P Dow Jones Indices (SPDJI) methodology, it outlines how the index can allocate up to 33% to a single company at each rebalance, with all remaining companies being capped at 19%.
In sum, DFND appears a more orthodox defence exposure, but the theme purity and potential overconcentration in some of its larger components warrant consideration.
One area where BlackRock’s new ETF goes unrivalled is on fees, with a total expense ratio (TER) of 0.35%, compared to 0.49% for NATO and 0.55% for DFNS. While fees do not define total cost of ownership, they go a long way in decision-making for strategic allocations.
