Defence ETFs are a new asset allocation tool for fund selectors looking to protect portfolios against rising geopolitical risk and capture the increase in military and cybersecurity spending across western countries.
Earlier this week, President Joe Biden signed a bipartisan aid bill to provide $95bn in support for Ukraine, Israel and Taiwan.
The package is just the latest sign of rising geopolitical tensions across the globe, most notably in Ukraine and the Middle East.
Russia’s invasion of Ukraine in February 2022 brought into sharp focus the need for western governments to increase military spending, with many NATO members still behind their commitment to spend 2% of GDP on defence.
Furthermore, geopolitical tensions in the Middle East continue to mount after Iran launched over 300 missiles towards Israel earlier this month in response to its attack on the Iranian embassy in Syria.
In an increasingly unstable world, measuring geopolitical risk and its potential impact on portfolios is challenging for fund selectors.
In response, three asset managers have launched defence ETFs in Europe over the past year to offer investors an alternative solution to take advantage of the increasing government focus on military and cybersecurity spending.
Portfolio construction
Kamil Sudiyarov, ETF product manager at VanEck, told ETF Stream defence ETFs should be viewed as a defensive equity play for multi-asset investors.
“Not only could it provide a hedge against geopolitical turmoil, but the defence industry companies on their own are known for relatively stable cash flow patterns due to the government-related nature of their businesses,” he added.
“Investors should keep in mind the sectoral concentration of the ETF and only consider it as a part of their satellite allocation.”
His views were echoed by Tom Bailey, head of ETF research at HANetf, who pointed to the role of defence ETFs as a hedge against geopolitical risk.
“Just as certain events lead to a ‘flight-to-safety’ in the form of buying safe-haven assets, we can call the buying of defence stocks a ‘flight-to-arms’,” he added.
ETFs
Demand for defence ETFs has been strong. VanEck currently offers Europe’s first and largest defence ETF, the $615m VanEck Defense UCITS ETF (DFNS) which offers exposure to 28 defence technology, large-scale cybersecurity and defence-relevant service provider companies.
It also adopts a controversial weapons screen that excludes companies involved in anti-personnel mines, cluster weapons, biological, chemical and incendiary weapons, nuclear weapons outside of the Non-Proliferation Treaty, depleted uranium and white phosphorus.
Next is the $336m Future of Defence ETF (NATO) which offers exposure to companies involved in the manufacture and development of military aircraft and defence equipment or have cybersecurity operations contracted by NATA countries.
The most recently launched defence ETF is the iShares Global Aerospace & Defence UCITS ETF (DFND) which offers exposure to 53 stocks – almost double the other two ETFs – via the S&P Developed BMI Select Aerospace & Defense 35/20 Capped index.
Final word
Navigating geopolitical risks is a challenge for fund selectors, however, defence ETFs are one way to maintain exposure to equities while benefitting from increased volatility in the market.
