Long excluded on moral grounds, investors are now reevaluating whether defence can fit into an ethical investing framework.
By Jack Arrowsmith, London
For 15 years, the Church Commissioners for England operated a highly restrictive policy on defence.
The endowment fund precluded any exposure to companies where more than 10 per cent of their revenue came from defence applications.
But times have changed. Following published advice from the Church of England’s Ethical Investment Advisory Group (EIAG) on how its investment bodies should be approaching defence, that restriction is gone.
In its place is an exclusion for controversial weapons and oppressive regimes. NATO and UK opportunities are then evaluated case by case.
The move comes during a period of seismic change for the defence industry. For decades after the end of the Cold War, European countries rode the wave of a peace dividend that allowed them to maintain small defence budgets, while the risk of conflict was low and they enjoyed protection from the US umbrella.
The realities underpinning that confidence have now largely been extinguished. The Russia-Ukraine conflict has seen war return to Europe, and the US is looking to scale back its protective role. The result is that many European countries have set off on the road to rearming, and with that comes investors reevaluating their exclusions.
“After the peace dividend, rebuilding stockpiles is a decade-plus long journey,” says Davide Vidotto, managing director at Bain Capital.
This means governments are providing investors with a reliable stream of cash for the foreseeable future. At the 2025 NATO summit in the Hague, members committed to spending 5% of GDP on defence by 2035, despite most of the alliance currently committing below half of that.
The likelihood, therefore, is at least nine years of growing defence budgets across Europe.
“Many of these products are ordered years in advance, so you can have a strong backlog of inventory to bank on,” Vidotto adds.
Blurred lines
For many groups of investors, meaningful exposure to defence has long been prohibited by their ethical commitments. Gaining access means reviewing those approaches – a process that has been helped by the growth of so-called ‘dual use’ technologies, with both civilian and defence applications. Such investments can be seen as more ethically acceptable given that they do not generally cover offensive weapons.
For the Church Commissioners, its new policy was a reflection of how the defence industry is changing. It has previously defined defence investments in terms of “combat readiness”.
“That was a very broad catch all” explains Dan Neale, social themes lead at the endowment fund. “It could cover companies that make missiles right down to companies that make uniforms.”
Capturing the dual use opportunity required making the move to restrictions on controversial weapons and oppressive regimes.
An example of this model is ITP Aero, an aerospace and engine component supplier which Bain Capital acquired from Rolls Royce in 2021, for €1.7bn.
“The majority of their business is in commercial aviation, but there is a sizable share in defence aviation,” explains Vidotto.
The social case
For some investors, defence investments are not only compatible with ethical commitments, but serve them directly.
“What we started asking ourselves was, can you really have a sustainability-focussed company or economy without it operating in a secure, stable environment?” says Andrew Bloxham, a partner in investment manager Foresight Group’s private equity division.
The argument is that funding the protection of society has a clear positive social impact, reconciling defence with ethical investing frameworks.
Foresight has a history of investment in sustainable infrastructure. It now evaluates defence opportunities on a case by case basis, with prohibitions on controversial weapons and exposure to countries with human rights violations. Foresight previously had a broader prohibition on defence investments.
This was the basis on which Danish pension fund AkademikerPension removed its restrictions on investment in six European arms manufacturers last year, previously excluded due to their links to nuclear weapons.
“Europe’s rearmament is likely to create attractive investment opportunities in the years ahead, not least in the unlisted space. As a responsible European investor, we also believe we have a role to play in supporting this effort through our capital allocation,” explains Anders Schelde, CIO of the fund.
The unintended consequences
Some investors find themselves exposed to defence unintentionally, irrespective of their ethical standards.
This is a consequence of the fact that defence supply chains can be particularly opaque. While this can be for good reason (defence investments will often concern classified information) it becomes a challenge for investors to maintain control of the ethical profile of their portfolios.
What is required is an understanding of not just firms’ customer bases, but everything up to the end-markets into which they sell.
Here, there is some previous experience on which to draw. “[Defence investing] is a complex due diligence exercise, but I wouldn’t say that it’s new. For instance, due diligence of supply chains for carbon emissions can be similar in many respects,” explains Vidotto.
Large companies deemed to be covered by the EU’s Corporate Sustainability Reporting Directive have to report their Scope 3 carbon emissions. These are indirect emissions which come from a company’s upstream or downstream value chain, evaluated across 15 categories.
Other companies outside of these regulations can also choose to report Scope 3 voluntarily. Last year analytics provider ISS-Corporate found that 29 per cent of the 8,231 public companies which it tracks report Scope 3 emissions.
For defence, the Church Commissioners is working as part of a global initiative, dubbed Guidance for Responsible Investment in Defence, to help codify the due diligence process. The report, set to be published before the end of the year, will focus on the potential for downstream concerns in the value chain.
Its goal is to serve as a framework for other investors to use, to ensure that they can make defence investments with the confidence that they are continuing to meet their ethical commitments.
With ethics concerns long having been the reason investors shied away from defence, the growth of dual use opportunities and the development of investing frameworks could help them get comfortable with this sector.
But at the rate that defence is growing, adaptation becomes equally important.
As businesses look to capitalise on the dual use opportunity, changes can quickly be made to their operations which pose concerns for long-term investors.
Neale says that GPs “could invest in a software company halfway through your term, [then] it pivots and becomes a defence company”. He adds that the Church Commissioners are working with managers to understand their excuse rights on these investments.
One example is German technology company Quantum Systems. Originally a manufacturer of surveillance drones primarily for military applications, it has since moved to offering its technology for military purposes following Russia’s invasion of Ukraine.
Investor opposition has had some impact, limiting the defence applications to reconnaissance and surveillance activities. But the company is now weighing a merger with Stark, a manufacturer of offensive drones, having used a funding round to provide shareholders who are uncomfortable with the pivot the chance to exit.
Supply chains pose challenges of their own. Even exposure to UK-based defence companies can quickly become a stakeholder management exercise.
UK public company BAE Systems has faced extensive criticism for its role in manufacturing components for the F-35 jet, which has been used by the Israeli military in Gaza.
The pressure on investors which follows can be sizeable, particularly when LPs are accountable to the wider public.
In Britain, the public is divided. According to polling conducted by Montfort Communications on behalf of platform The Business of Defence, 21% of the British public are uncomfortable with their personal money contributing towards defence, with a further 23% either neutral or unsure. 43% are comfortable, while 13% are comfortable provided the investments are for defensive use only.
There is also no reason to believe the institutions themselves will agree on how to approach defence. In response to the EIAG’s advice, the Church of England Pensions Board chose instead to further tighten its restrictions.
Defence must now make up no more than five per cent of a company’s revenues, down from ten per cent, for investment from the Pensions Board to be eligible.
For Neale, the fact the institutions drew different conclusions from the same advice is simply a reflection of their responsibilities.
“We have different mandates, different horizons and also some different stakeholders. I think it’s a useful demonstration that we are actually looking at this differently.”
These differing responsibilities inevitably lead to a range of approaches. But the continued growth of defence challenges how all investors approach the sector, and whether it is time to include it in their portfolios.
