In the relatively peaceful post-Cold War era, governments around the world were able to implement large-scale cuts to defence budgets and redirect these funds elsewhere in the economy – a process often referred to as the ‘peace dividend’.
However, the ongoing war in Ukraine, tensions between China and Taiwan and various Middle Eastern conflicts in recent years has drawn increased focus on how this sustained underinvestment has hindered domestic defence capabilities.
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Which defence ETFs are available?
As new competitors enter the market, there will naturally be winners and losers for those successful in obtaining the rewards on offer from government contracts. As a result, many investors have sought a basket of stocks to diversify across the defence industry.
As with many thematic ETFs, there is not a standardised method for capturing the theme in question. As a result, some of the indices and products attempt to target the wider defence ecosystem which presents a trade-off with the level of revenue purity to the theme – something to bear in mind if looking to make an allocation to a defence ETF.
While the fund providers gave us their revenue purities of the respective index/ETF, we are conscious that the differences in methodologies and classifications inhibit a direct comparison between the products. Therefore, the revenue figures stated below are based on Bloomberg’s REVB function that provides a weighted exposure to the ‘defence’ industry as defined by Bloomberg’s classifications. Please note that those indices using revenue screens in their methodologies may use different classifications and revenue breakdowns to those used by Bloomberg. Additionally, the ETFs have exposure to several different industries not stated below.
VanEck Defence UCITS ETF
This was the first defence ETF to be launched in March 2023 and aims to track the MarketVector Global Defence Industry Index. The index selects companies involved in the defence industry, including related national/federal governmental departments that derive at least 50 per cent (25 per cent for current components) of their revenues from the following themes:
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- Aerospace and Defence products and services.
- Communications systems and services (including satellites).
- Unmanned vehicles.
- Event response, security, or safety-related software.
- Information Technology hardware and services.
- Cybersecurity software.
- Training and simulation software and products.
- Digital forensics, detection devices, and e-authentication/biometric identification.
Although the ETF sits at the top end in terms of product fees (OCF: 0.55 per cent), first-mover advantage has benefited VanEck with the ETF having taken a large share of flows with the product now standing at around $2.3 billion in size.
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HanETF Future of Defence UCITS ETF
This ETF tracks the EQM Future of Defence Index. For the industrial defence component, companies included in the index must derive more than 50 per cent of their revenues from the manufacture and development of military aircraft and/or defence equipment (military armoured vehicles & tanks, weapon systems and missiles, munitions and accessories, electronics & mission systems, and naval ships), defence technology applications.
There is not a revenue screen for the cyber component but instead these companies have at least 2 contracts with a Nato+ member nation. Constituent business operations must be in compliance with United Nation Global Compact (UNGC) principles and Organisation for Economic Cooperation (OECD) Guidelines for Multinational Enterprises.
The ETF has an OCF at 0.49 per cent with an AUM of $927 million. A noticeable difference for this ETF is its skew towards digital defence as demonstrated by the largest exposure to the Technology sector at 45 per cent. Modern warfare is no longer confined to bullets and missiles, it is increasingly being played out in the digital realm. The increasing frequency and severity of cyberattacks are placing more importance on protecting digital infrastructure due to the potentially catastrophic economic ramifications these attacks can entail on governments, companies and individuals.
Global X Defence Tech UCITS ETF
Global X Defence Tech UCITS ETF tracks the Mirae Asset Defence Tech Index and is designed to track the performance of companies in Defence Technology, which are positioned to benefit from technology, services, systems, and hardware that cater to the local and/or national security, defence, and military sector. The index selects the top 50 global companies earning more than 50 per cent of revenue from three sub-themes: Cybersecurity, Defence Technology and Advanced Military Systems and Hardware.
Albeit a very small allocation, there is currently only one company that falls under the Cybersecurity bucket (Telos, a US information technology services and cybersecurity company) – this though does not mean there won’t be more in the future providing the criteria for inclusion is met.
It is worth pointing out that the index methodology states that company activities involved with manufacturing commercial aircraft components, aircraft interiors, and other components are not considered in contributing to Defence Technology revenue. Therefore, the index/ETF does not include the likes of Boeing and Airbus in their holdings as they do not meet the purity revenue requirements.
The index/ETF is the most concentrated of the ETFs reviewed when looking at its allocation to the top ten holdings which currently account for 72 per cent. The top allocations are to Palantir Technologies 9 per cent, Rheinmetall 8 per cent and RTX 8 per cent. It has concentrated exposure to the defence industry given its focus on revenue purity and picks up a lot of the major defence players that we would expect to see represented in the index/ETF. However, given its recent launch (September 2024) the ETF has a very small AUM ($15 million) and relatively wide trading spreads currently.
Invesco Defence Innovation UCITS ETF
Invesco Defence Innovation UCITS ETF tracks the S&P Kensho Global Future Defence Index. The index utilises an automated scan of companies’ most recent regulatory filings to identify specific search terms and phrases that link the company’s products and services to the below business activities:
- Smart borders and securing critical infrastructure.
- Military applications of: Cyber security, Space systems, Robotics, Remote operated or unmanned air and sea drones, Wearable technologies, Virtual or augmented reality.
Index analysts review and approve the final constituents to be included. Companies are then classified into two groups, “Core” or “Non-core”. Core companies derive a significant portion of their business operations and/or revenues from products and services aligned with the theme (there is no minimum revenue requirement set to determine ‘significant’). Non-core companies operate across the broader value chain of the theme, providing vital inputs such as critical subcomponents to the end products aligned to the theme, but not focusing on delivering these end products themselves. An overweight factor is applied to the group of Core securities relative to the Non-core. Within each group companies are equally weighted subject to diversification and liquidity constraints.
Of the ETFs listed here this contains the greatest proportion in smaller companies, typically adding to the risk involved, plus it is the most differentiated from competing products. It is the only ETF to have allocations to the Communications, Energy and Healthcare sectors.
First Trust Indxx Global Aerospace & Defence UCITS ETF
This is the newest (and most expensive with an OCF of 0.65 per cent) addition to the menu of defence UCITS ETFs and tracks the Indxx Global Advanced Aerospace & Defence Index. This selects the top 50 companies included within the ‘Aerospace and Defence’ sector as defined by Indxx – companies included fall under the following sub-themes:
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Advanced Aerospace and Defence:
- Hypersonic.
- Directed Energy.
- Space Technologies.
- Unmanned Aerial Vehicle/ Advance Air Mobility.
- Autonomous, Cybersecurity, and C5ISR Systems.
- Traditional Aerospace and Defence: companies that manufacture construction material, electronics and telecommunications equipment used in the manufacture of aircraft for both defence and commercial aviation. Avionics, power and control system, interiors, manufacturing of airframe rotables, landing gear and other accessories are examples of common applications in both defence and commercial aviation.
This is the most geographically diverse option reviewed with 14 countries represented in the index/ETF and is the only ETF to have an exposure to India (Bharat Electronics and Hindustan Aeronautics). It also has the highest allocation to the UK. Despite this is has considerable overlap with the iShares ETF and given its recent launch in December 2024 it is currently small with relatively wide trading spreads.
