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The Case for Defence

Many investors avoid weapons financing due to human rights risk, but for others the battle lines are blurred.  

We might all instinctively agree with Edwin Starr that war is good for absolutely nothing, but his heartfelt assertion is not strictly accurate.  

Following the Hamas attack on Israel in October last year, which resulted in over 1,000 civilian casualties, the market value of some of the largest US-based arms companies increased by around US$23 billion on the prospect of increased sales. 

A rather grim, yet thought-provoking outcome. 

“Over the last 40 years, there has been massive privatisation of weapons manufacturers – meaning there have been huge opportunities and risks for investors in terms of responsible investments in this space,” Phil Bloomer, Executive Director of the Business & Human Rights Resource Centre (BHRRC), tells ESG Investor 

Conflict is a global market supported by large companies across many sectors, from selling surveillance technologies to repressive regimes in Egypt and Libya, to financing the military junta in Myanmar. 

From the perspective of ESG-focused investors, funding weapons, conflict and surveillance is a highly complicated topic. While investing in weapons may boost portfolio performance, such investments also come with big human rights-related risks attached – not to mention environmental implications 

It is also difficult to measure – and therefore manage – portfolio exposures to these, due to the opacity of weapons supply chains. 

“Given the extensive risks associated with lethal weapons, any responsible investor has to be uncompromising and unstinting in their application of heightened human rights due diligence,” Bloomer says. 

As such, some investors have drawn a line in the sand. Norway-based asset manager Storebrand recently excluded First International Bank of Israel for its involvement in the Occupied Palestinian Territory, while a number of major European banks and pension funds divested from Israeli weapons manufacturer Elbit. 

Many investors also have weapons-focused exclusions enshrined in their investment policies. Goldman Sachs Asset Management’s 2024 statement on sustainable investing, for instance, alluded to its exclusionary framework – which included civilian firearms and controversial weapons. In addition, the asset manager collaborated with S&P Dow Jones Indices to launch the S&P Environmental & Socially Responsible indices, which automatically exclude companies that derive revenue from weapons. 

“Investors need to know who is selling what throughout the value chain,” says Bloomer. “There should be absolutely no investments in any weapons or intelligence systems that are outside of international humanitarian laws, such as cluster bombs, landmines and nuclear weapons.”

Investors need a rigid international humanitarian law screen with zero tolerance, Bloomer contends. 

Concealed arms 

However, for some investors, the line appears to be blurred on what passes as ‘acceptable’ weapons funding.  

“It’s very hard to escape the fact that war is a nasty thing and, as an investor, you may have exposures to it,” says Sondre Myge, Head of ESG at SKAGEN Funds – an active investment boutique.  

As of April 2022, 44% of assessed sustainable funds had some exposure to military contractors in their portfolios, according to Morningstar, compared to 60% of non-ESG-labelled funds. 

In the UK, over £1 billion (US$1.28 billion) has been invested by 52 local government pension scheme funds in firms supplying weapons or systems to Israel. 

Index providers MSCI, FTSE Russell and S&P Dow Jones Indices recently refuted claims that they had allowed ESG-labelled investments contributing to Myanmar’s military regime. 

More recently, a report published by the Global Alliance for Banking on Values (GABV) outlined the extent to which the global financial sector has been financing conflict. It found that at least US$1 trillion was invested in the arms industry between 2020 and 2022 – nearly half of which came from the US finance sector and US$79 billion from Europe’s top-ten investors.  

The GABV is a network of independent banks using finance to deliver sustainable economic, social and environmental development. 

“The GABV believes that finance is not neutral and has a responsibility to people and planet not to finance the production or trade of any weapons and arms,” says Martin Rohner, the GABV’s Executive Director. “Where there’s risk of human rights abuses, we would expect investors and lenders to reconsider their position in line with their duties by divesting and excluding [these assets].” 

Meanwhile, 100% of GABV members do not finance the industry, with 73% of GABV members having adopted explicit policies excluding weapons from any loans and investments. 

Peace is a precondition for sustainable development where we can effectively address the big global issues, such as climate change,” Rohner adds. 

Best line of defence 

On the other side of the debate, some argue that investors have a duty to invest in national security and protecting those threatened by aggressors. 

Newton Investment Management has declared that it does not think defence stocks are incompatible with ESG criteria, and that not everything should be bucketed as ‘sustainable’ or ‘unsustainable’. “There are things, such as defence, that are necessary for functioning societies,” the group deems. 

In 2022, Finnish pension fund Varma updated its investment approach to the defence industry.  

“Varma may invest in defence industry companies under certain conditions – such as if activities related to controversial weapons account for less than 5% of the their activities, and if the primary purpose is to prevent conflicts and defend sovereignty,” explains Hanna Kaskela, Senior Vice President of Sustainability at Varma.  

Varma has also said it would not invest in the government bonds of countries ranked in the bottom 25% of the UN’s Sustainable Development Goals index. 

Analysis from Bloomberg showed that 1,238 funds self-described as ESG-focused held stocks in defence and aerospace companies as of November 2023 – 25% more than in March 2022. 

“A correct vantage point for investors would perhaps be that any assistance to upholding democratic and free societies should be considered worthy of an ESG or responsible investor lens,” suggests SKAGEN’s Myge. 

Pressure point 

The extent to which private investors invest in domestic and regional defence has become a growing point of contention between governments and the private sector globally. 

In November 2022, Dutch pension funds resisted a call to increase investments in weapons manufacturers. More recently, UK Defence Secretary Grant Shapps argued that funding defence companies should count towards sustainable investing, as it helps to prevent war.  

Europe’s defence industry has also lobbied hard to persuade officials to consider weapons investment as a sustainable economic activity. Earlier this month, the European Commission unveiled plans to boost the bloc’s arms industry. 

“We see investment in the manufacture and trading of weapons as the dealings of governments and not the private sector – war and conflict should not be a business,” says Rohner.  

There is “a fine line between what is being used purely for defence, and what can be used for strategic warfare”, he adds. 

Investors do have a critical role to play in supporting peoples’ right to self-defence, but they should not support weapon exports to countries that have an aggressive ideology, like Russia, Bloomer from BHRRC adds.  

“There is a big problem with double standards in the West, as displayed through the support for Ukraine and contrasting actions regarding Gaza,” he continues. “Unless they are careful, investors can quite quickly become embroiled in this.” 

In 2022, UK arms sales reached a whopping £8.5 billion – 54% of which went to countries designated as “not free” by human rights group Freedom House, including Saudi Arabia and Qatar. 

In these instances, responsible investors can also consider applying international human rights laws to their investment strategies, such as the UN Global Compact, the UN Guiding Principles on Business and Human Rights, and the Arms Trade Treaty, as well as any relevant sanctions. 

“However, none of these provide very clear expectations as to what investors ought to be doing specifically around investment in weapons and intelligence,” Myge argues. 

Grey area 

Overall, experts seem to agree that the decision to invest in or divest from the weapons sector must ultimately be evaluated on a case-by-case basis.  

“An investor can act responsibly while investing in weapons, but opportunities to do so are very limited,” says Bloomer. “They can only invest in those who have a track record of policies and practices that clearly exclude the extraordinary risks associated with the sale of those weapons [and intelligence] systems to third parties.” 

However, Bloomer remains unconvinced that weapons have a place in ESG-labelled funds. He points to ongoing pressures on sustainable investing from the anti-ESG movement, the many intricacies surrounding investment in weapons, and ever-growing geopolitical tensions globally – which all add to the complexity of the debate. 

“The possibility of being accused of demonstrating double standards and inconsistency is likely very high,” he warns. 

For its part, SKAGEN’s funds have limited exposure to portfolio companies with minor stakes in general military contracting and conventional arms.

“The key to avoiding any potential reputational risk surrounding this is to be as transparent as possible, as [it] is often made worse by pretending something isn’t there,” Myge explains. 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

Copyright © 2024 ESG Investor Ltd. Company No. 12893343. ESG Investor Ltd, Fox Court, 14 Grays Inn Road, London, WC1X 8HN

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