By Roel Houwer, Senior Product Manager at VanEck Europe 

When Donald Trump made his incendiary remark in February that the United States would not defend NATO allies that did not meet spending targets, he sent a shudder through the alliance. For the first time since the North Atlantic Treaty Organization was set up in 1949 by the US, Canada and several Western European nations to provide collective security against the Soviet Union, the support of its biggest military power appeared conditional.

Of course, Trump is not president and may not triumph in the November 2024 US presidential election. But it seems that the quip served as a wakeup call, making the Europeans realize that they could perhaps not rely on the US for defense.

Ever since the conflict between Russia and Ukraine in 2022, defense production lines have been ramped up and defense company stocks have been rising. Until then, many western countries had let their armed forces decline in an era of ostensibly enduring peace. With geopolitical tensions ratcheting higher, though, they are urgently seeking to rearm.

Military spending reaches new highs

The situation in Ukraine and tensions in the Middle East have driven world military expenditure to a new all-time high, according to the Stockholm International Peace Research Institute (SIPRI). Total global military expenditure increased by 3.7% in real terms in 2022, to reach $2,240 billion, with by far the largest increase in Europe, largely accounted for by Russian and Ukrainian spending. This is SIPRI’s latest data and does not reflect subsequent increases in spending.

After failing to meet the NATO target of spending 2% of their gross domestic product on defense for many years, more and more European countries are aiming to do so, with some looking to exceed it. Not least is Germany, the EU’s largest economy, which has pledged to meet the 2% target in 2024 for the first time since the Cold War ended at the beginning of the 1990s (source: SIPRI). What’s more, Ursula von der Leyen, European Commission president, has even proposed that the EU budget should subsidize defense production.

With military spending surging, the stock prices of many defense companies are increasing quickly, both in reaction to announcements of higher profits and in anticipation of further growth to come. As the first defense ETF to be launched in Europe, the VanEck Defense ETF is a good proxy for defense stocks. From its inception on 31 March 2023 to 2 April 2024, the ETF has risen by 50% (in US dollars) . However, investors need to evaluate the long-term performance of the ETF before making any investment decision, past performance is no guarantee for future results and investors run the risk of capital loss when investing in equity..  As ever, that averages out a range of performances from its 28 underlying holdings, please refer to the fund prospectus before making a decision to invest.

Pure play exposure

For investors seeking to invest in the defense theme through ETFs, VanEck offers the VanEck Defense ETF. It is currently the largest defense ETF in Europe at USD 496.1 million, and is arguably the purest play on the defense sector. That’s largely because its holdings must derive 50% of their revenues from the military or defense industries (25% for current holdings). This stipulation means the ETF better captures the pure performance of the defense industry. To give a sense of its holdings, the top two are currently the French companies Safran and Thales while the third is the US company Leidos Holdings.

Avoiding controversial weapons

The ratcheting up of geopolitical threats appears to be making defense companies more acceptable for investors that previously would not have held them on ethical grounds. Some companies make the case that military hardware is necessary to defend democracies, and this argument is gaining acceptance. However, controversial weapons are likely to remain a step too far for some.

Mindful of this distinction, the VanEck ETF applies a controversial weapons screen, excluding those companies which revenues derived from  Anti-Personnel Mines, Biological and Chemical Weapons, Cluster Munitions, Depleted Uranium, Incendiary Weapons, White Phosphorus and Nuclear Weapons outside the Non-Proliferation treaty.

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