Modern armaments are often precise. ESG is generally fuzzy. Funds with environmental, social and governance aims may be precluded from backing Ukraine. They need to be more discerning.
The Russian invasion has forced liberals to rethink the role of arms companies. Businesses once dismissed as merchants of death are now key to defeating a brutal invasion. Governments across the democratic world are supplying Ukraine with weapons from dwindling stockpiles.
Military spending is surging. It includes a €100bn special fund from previously ambivalent Germany. The EU is planning to finance weapons for Ukraine out of its own budget.
There is little sign of a rethink among European investors. Prior to the crisis, more than 20 per cent of mutual funds excluded weapons manufacturers, according to research by Deutsche Bank. Anecdotally, some fund managers have reviewed their policies. Otherwise, little has changed.
While the number of ESG funds investing in defence has ticked up marginally, managers in this space are still 70-90 per cent underweight, according to Goldman Sachs. That matters, because about $2.7tn of assets are invested in equities in accordance ESG policies. Inflows are high.
Ethical investors pursue objectives they individually consider meritorious. ESG investment is a flawed elaboration of this worthy concept. It elides three incongruous purposes via the straitjacket imposed by standardised indices.
The exclusion of defence stocks from ESG funds has negative consequences. Firstly, it raises the cost of capital when arms makers invest. This means western governments will supply fewer weapons to Ukraine for the same cost.
Secondly, ESG funds have missed out on decent returns from a good cause. Revenue growth in the European defence sector is expected to average 10 per cent a year to 2025 according to Bernstein.
Shares in Germany’s Rheinmetall and Saab of Sweden have more than doubled since the start of 2021. BAE of the UK, which may establish a manufacturing base in Ukraine, is up 90 per cent.
European defence stocks traded at a 40 per cent price-earnings discount to US peers in 2018. The gap has halved, says Barclays.
The reluctance of ESG investors to buy defence stocks is an example of refusing to change your mind although the facts have changed. A movement aiming for ethical superiority risks becoming detached from reality.
The Lex team is interested in hearing more from readers. Please tell us whether you think out argument on defence stocks is right or wrong in the comments section below.