Investors take another look at defence

Institutional investors with long-standing ethical investment restrictions are systematically reassessing their defence sector exclusions, driven by geopolitical realignment and the emergence of dual-use investment opportunities. The Church Commissioners for England—managing a substantial endowment—terminated a 15-year policy prohibiting exposure to companies deriving more than 10% of revenue from defence. The shift reflects guidance from the Church of England's Ethical Investment Advisory Group recommending case-by-case NATO and UK defence evaluations while maintaining exclusions for controversial weapons and oppressive regimes.

The policy pivot stems from structural changes in European defence spending. Following the Russia-Ukraine conflict and anticipated U.S. security pivot, NATO members committed at the 2025 Hague summit to increasing defence expenditure to 5% of GDP by 2035—a target most current members fall substantially short of, suggesting minimum nine-year budget expansion. Davide Vidotto, managing director at Bain Capital, emphasizes that "rebuilding stockpiles is a decade-plus long journey," creating predictable government cash flows for defence contractors and suppliers. This visibility contrasts sharply with post-Cold War austerity that discouraged defence investment for three decades.

The growth of dual-use technologies—products serving both civilian and military applications—is reshaping investor ethics frameworks. Bain Capital's 2021 acquisition of ITP Aero from Rolls Royce for €1.7 billion exemplifies this model: the aerospace and engine component supplier derives majority revenues from commercial aviation while maintaining significant defence aviation exposure. This architecture allows ethically-constrained investors to gain meaningful defence exposure without investing in offensive weapons platforms. Institutional investors including Foresight Group and Danish pension fund AkademikerPension have removed blanket defence prohibitions, adopting case-by-case screening aligned with human rights and weapons controversy exclusions.

However, defence supply chain opacity presents material risks. Unlike carbon emissions tracking under EU Corporate Sustainability Reporting Directive frameworks, defence due diligence requires tracing investments through classified supply networks where end-market applications may shift during fund tenures. Quantum Systems, initially focused on military surveillance drones, pivoted post-2022 to offensive reconnaissance capabilities following investor pressure, then pursued a merger with offensive drone manufacturer Stark. BAE Systems' extensive F-35 component manufacturing—used by Israeli military operations—illustrates how public and LP stakeholder pressure can escalate rapidly. The Church Commissioners is co-developing a "Guidance for Responsible Investment in Defence" framework expected before year-end to standardize downstream supply chain due diligence.

Institutional response remains fragmented. While the Church Commissioners liberalized restrictions, the Church of England Pensions Board tightened requirements further, capping defence exposure at 5% of company revenues versus the previous 10% threshold. This institutional divergence reflects differing mandates, investment horizons, and stakeholder accountability structures. As defence budgets accelerate across Europe, investor adaptation will become increasingly critical to portfolio construction, though ethical frameworks will continue fragmenting across institutional constituencies.