NATO’s upcoming summit in The Hague is expected to mark a decisive turning point, as the alliance moves to formally abandon Europe’s post-Cold War “peace dividend” mindset in favour of a coordinated surge in defence investment – elevating the spending guideline from 2 per cent of gross domestic product to potentially 3.5 per cent.
Some key members are even advocating for 5 per cent, amid heightened geopolitical threats and renewed commitments from major EU nations, including Germany, France, the UK, Sweden, and the Netherlands.
In recent months, defence stocks, especially in Europe, have rallied sharply, buoyed by heightened security concerns and sweeping commitments to rearmament.
As a result, defence exchange-traded funds (ETF) have flourished both globally – net inflows of US$7.5 billion since the start of the year – and locally, where they attracted $75 million of flows to become one of the most successful ETF themes to launch in recent years in Australia.
Speaking to InvestorDaily this week, investment strategist at Betashares, Tom Wickenden, said recent inflows into defence ETFs appear “fairly sustainable”, particularly if NATO adjusts its targets at its upcoming summit.
“Talking about [a] 3.5 per cent level for NATO countries, we’re talking about an additional $324 billion [USD] per year going towards defence-related rearmament or spending,” Wickenden said.
“If we see that, and we see the level of growth for these defence companies, we can easily see [more growth] from investors.”
All up, defence ETFs hold over $31.9 billion in FUM – an increase of 24 per cent since the start of the year. Betashares’ Global Defence ETF alone has returned 43 per cent since inception on 2 Oct 2024.
As a whole, defence stocks in Europe have entered a boom period in recent months, with the pan-European Stoxx Europe 600 Index gaining 8.45 per cent year-to-date.
Much of this has been driven by the success of European companies such as Rheinmetall, Germany’s largest defence contractor, which has returned 185 per cent this year alone.
But while European defence companies have benefited the most from recent developments, Wickenden said it is important to remember just how significant the large US players are.
Don’t count out US defence giants
The US’ 2024 defence budget was US$840 billion – two and a half times the EU spend.
The top five US pure play defence companies (Lockheed, RTX, Northrop, General Dynamics, and L3Harris Technologies) generated US$330 billion in revenue in 2023 – two and a half times of every European and UK defence company in the top 100.
“Remember, the US companies are by far the largest in the world … these US giants do not just generate revenue domestically,” he said.
“Their scale and expertise mean that ally countries rely on them to provide top of the line defence capabilities. From 2020 to 2024, US defence companies accounted for almost 50 per cent of weapons exports globally, more than four times the next largest country.”
Wickenden suggested that the US defence companies stand only to benefit along with their EU counterparts from greater European spending.
“I may be wrong, but it seems unrealistic to think that Europe will re-armour without relying on the US’ superior defence capabilities – notwithstanding the current politics playing out.”
Also this week, speaking on the defence theme at the Morningstar Investment Conference, GQG chief investment officer and chairman Rajiv Jain acknowledged that while the firm holds “some exposure” to defence stocks, it has not been enough.
The challenge for GQG has been identifying suitable investment opportunities within the defence sector.
“The theme is there; it is just hard to find names to play on. Because there are a few names and they’re trading as if they’re going to grow earnings at almost 20x for a long time. That’s very hard to execute. These are not software companies,” he said.
“So, to transition to where they have been to grow at that rate would be complicated. Of course, defence spending is going up … It is a seismic change that we are seeing, and we feel that we have to be careful,” Jain said.
Jain added that GQG has been cautioning clients against extrapolating trends from the post-GFC era, warning: “That will not continue. The winners and losers will look very different in the next five to 10 years than the last five to 10 years.”
