Future of Defence ETF Report | May 2024

Defence and Aerospace ETF Key Takeaways

Global military spending surges amid war, rising tensions, and insecurity – Total global military expenditure reached $2443 billion in 2023, an increase of 6.8% in real terms from 2022. This was the steepest year-over-year increase since 2009. The 10 largest spenders in 2023—led by the United States, China, and Russia—all increased their military spending.  World military expenditure rose for the ninth consecutive year to an all-time high level and, for the first time since 2009, military expenditure went up in all five of the geographical regions defined by Stockholm International Peace Research Institute (SIPRI). The unprecedented rise in military spending is a direct response to the global deterioration in peace and security.  For European NATO states, the past years of war in Ukraine have ‘fundamentally changed the security outlook,’ said Lorenzo Scarazzato, Researcher with SIPRI’s Military Expenditure and Arms Production Programme. This shift in threat perceptions is reflected in growing shares of GDP being directed towards military spending, with the NATO target of 2 per cent increasingly being seen as a baseline rather than a threshold to reach.

European investors reassessing defence – According to a recent article in the Financial Times, European investors are overcoming their traditional reluctance to investing in the defence sector and are putting money into recently launched UCITS ETFs in Europe. European pension funds have traditionally excluded defence stocks on ESG grounds, but it seems investors in funds like NATO are now viewing defence stocks as a hedge against geopolitical risk. They are also embracing the longer-term structural theme capturing the defence spend growth associated with the rearmament of Europe and NATO+ countries.  Russian aggression has also caused a reassessment of this ESG screen, balanced against the threat of security and democratic values in Europe.

NATO countries eyeing higher defence spending targets – Some European NATO member countries are calling for the alliance’s defence spending target to be raised to 3% of GDP from the current 2% level. The pressure to boost spending comes as the Russia-Ukraine conflict enters its third year. Poland and Greece are currently the only two EU countries in NATO that spend more than 3% of GDP on defence, alongside the United States. NATO countries are currently expected to spend 2% of their GDP on defence, but only 18 members are on track to do so; Germany hit that target for the first time this year. The EU’s top defence official is pressing for member countries to boost spending independent of the Russia-Ukraine conflict. The UK is also pushing for a new target of 2.5% given increased dangers in the world.

Sweden ramps up defence spending goal to 2.6%, above current NATO target – Sweden’s military spending is expected to rise to 2.6% relative to the size of its economy by 2030, with the newest NATO member planning to surpass the alliance’s common goal of 2%. By 2030, Sweden is expected to add 53 billion kronor (or $4.9 billion) in annual spending to its military budget. It also aims to double its forces from two army brigades to four and is targeting further investment into its air defence capabilities – including countermeasures against drone attacks. Post joining NATO last month, Sweden also aims to increase its focus on logistics and capacity to host allied troops, with its navy set to get four new warships by 2030.

Goldman warns of high valuation of European defence stocks – European defence names experienced their worst day in almost 18 months on April 9th, after Goldman Sachs cautioned the sector’s rally has elevated some price valuations. Goldman analyst Victor Allard said shares in firms such as Rheinmetall AG, BAE Systems, and Saab AB are now at “peak multiples” compared to history. That being said, all of these companies are also experiencing unprecedented levels of growth. Bernstein analysts said European defence firms’ earnings growth is expected to outpace US rivals this year and in 2025. They noted, however, that having languished at a 50% valuation discount relative to peers US in early 2022, European defence names have now closed much of the valuation gap.

Sources available upon request. Please remember that when you invest in ETFs, your capital is at risk.

Macro Outlook

Global military spending continues to trend at record levels, as countries ramp up their military spending in response to war, rising geopolitical tensions, and security concerns.  Total global military expenditure reached $2443 billion in 2023, an increase of almost 7% from 2022.

As the Russia-Ukraine conflict continues into its third year, many NATO members are advocating for increasing the NATO target spend from 2% to as much as 3% of GDP.  Already, new members like Sweden, are spending above 2% target levels.

Despite unprecedented levels of growth spurred by Europe rearmament and the modernization of its defence capabilities, some analysts are now concerned about high stock valuations. But European defence names are still expected to exhibit superior growth this year and next, relative to their US peers. It is no wonder, then, that European investors are taking a second look at the defence sector and investing heavily there, with ESG concerns being overturned given the context of rising global tensions and geopolitical risk.

Defence and Aerospace ETF Details

Future of Defence UCITS ETF (NATO) provides exposure to the companies generating revenue from NATO and NATO+ ally defence and cyber defence spending.

The fund tracks the EQM Future of Defence Index (NATONTR Index).

Visit the NATO fund page for more information.

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