Can you be a responsible investor and invest in defence?

What changed, and where

The clearest signal has come from Europe. Since Russia's invasion of Ukraine, the EU has addressed how defence sits within its sustainable finance framework and the Corporate Sustainability Due Diligence Directive, and national governments have pushed the same way. Defence names have since entered screened, ESG and sustainability-labelled portfolios across the region, and a Hanetf survey found 94% of fund managers would consider adding defence stocks to an ESG portfolio.

The underlying argument is not that weapons are responsible investments. It is that security is a precondition for everything else responsible investment cares about: democratic institutions, functioning markets, human rights and the energy transition. Energy security and supply-chain resilience made the same journey from “not an ESG issue” to “clearly an ESG issue”. Defence is travelling the same road, and Australian investors will be asked to form a view.

The screening problem: “Defence” is not one thing

The most useful lesson from building exposure in this sector is that an in-or-out blanket position is the least defensible one. “Defence” spans satellite communications, cybersecurity and detection hardware alongside munitions manufacture. Treating a cybersecurity provider and a cluster-munitions producer as a single asset class is not a fair assessment. The more workable approach is to test each company individually rather than judge the sector as a whole, against two specific questions: what is it verifiably involved in producing, and how does it conduct itself?

Three lessons worth taking to other sectors

First, specificity beats sentiment. A vague commitment to "avoid harmful industries" cannot be tested: it gives a client no way to check whether the policy was followed, and no way to say what would have to be true for a company to breach it. The point is not that a detailed screen is more virtuous than a general principle, rather it is that only one of them can be audited.

Second, check what you already own. Broad-based index funds, including many held inside ESG-labelled portfolios, may hold defence companies, some of which produce controversial weapons. An investor who has excluded a dedicated defence exposure while holding the same names through a market-cap benchmark should check the crossover for consistency.

Third, be clear about what a screen is not. Applying exclusions does not make a defence exposure a sustainability strategy, and it should not be presented as one. But protecting citizens and keeping them safe is the responsibility of governments and they are spending more and more on defence. It’s little wonder ethical investors are curious.

Product case study: Responsible investment in defence ETFs

VanEck's Global Defence ETF (ASX: DFND) tracks the MarketVector Global Defence Industry (AUD) Index. The Index includes only the largest and most liquid listed companies that generate at least 50% (25% for current constituents) of their revenues from military or defence industries. DFND does not have an ESG investment objective, nor does it promote ESG outcomes, however it aims to exclude companies that violate certain criteria included in the following categories: controversial weapons and norm-based research.

• Controversial weapons. Each company is assigned an overall red, amber or green flag based on its involvement in anti-personnel mines, biological and chemical weapons, cluster munitions, depleted uranium, incendiary weapons, white phosphorus, and nuclear weapons outside the Non-Proliferation Treaty. A red flag (verified involvement in the development, production, acquisition, stockpiling, retention or transfer of those weapons) makes a company ineligible for the Index. The assessment follows the corporate structure rather than stopping at the listed entity: it captures involvement through a company's own operations, a joint venture, a majority-owned (≥50%) or otherwise controlled subsidiary, or debt issued on behalf of a company that is verifiably involved.

• Norm-based research. The second screen evaluates whether a company has failed to abide by global norms on society, environment and governance, aligned with the UN Global Compact principles and the OECD Guidelines for Multinational Enterprises. Companies are scored from 1 to 10 on their link to violations of international standards covering human rights, forced and child labour, union rights, discrimination, bribery, money laundering and environmental protection, among others. A score of 10 means an authoritative body has verified a failure to respect established norms and the issue remains unaddressed; a 9 means the company has entered into a contract that would, when actualised, lead to such a failure. Either score makes it ineligible. The same look-through applies in the corporate structure.

That second layer matters more than it is usually given credit for. A weapons screen captures what a company makes; the norms screen captures how it behaves. Much of the genuine controversy risk in this sector sits in conduct, not in the product taxonomy.

Security is ultimately about safeguarding the conditions that allow people and societies to thrive, and investors will increasingly be asked how they intend to balance this with ESG considerations. As geopolitical realities evolve, responsible investors will need to decide not whether defence is good or bad, but where, why and under what conditions it belongs in a portfolio.

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<small> Any views expressed are opinions of the author at the time of writing and is not a recommendation to act.  

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<small> Disclaimer: The views and opinions expressed in this article are solely those of the author(s) and do not necessarily reflect the view or position of the Responsible Investment Association Australasia (RIAA).This article is intended as general information and should not be considered investment advice. It is recommended to seek appropriate professional advice before making any investment decisions.