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Until very recently, defence companies were a bit of a taboo subject in the investment world. Labelled ‘sin stocks’, they were lumped together with the likes of alcohol, tobacco and gambling firms, and screened out of many portfolios due to their negative impact on the world.
But in recent weeks the perception around these companies has changed. As we’ve witnessed Russia’s invasion of the Ukraine, they’ve moved from investment pariah – firms that help kill, maim and frighten – to having the Latvian deputy prime minister question: “Is national defence not ethical?”.
While they may remain a ‘no-no’ for funds fully embracing ESG, these stocks are certainly grabbing the attention of other fund managers.
In his recent podcast, Zehrid Osmani, manager of FTF Martin Currie European Unconstrained fund told us that cybersecurity and defence are one of his key investment themes.
“Cybersecurity for us is an important area of focus, which will be emphasised by corporates, given the crisis we’re going through,” he said. “There’s clearly more risk of cybersecurity attacks both at the national level, but also at the corporate level. And we think corporations are going to be spending more of their IT budget on cybersecurity.
“Then, on the security and defence side, you can see that Russia’s invasion of Ukraine and the tragic humanitarian consequences that we’re seeing, is leading nations to decide that they need to spend more on defence.”
Indeed, most European countries have increased defence spending in recent years, but several countries – most notably Germany – remain well below NATO’s target of 2% of GDP.
With reports of navy-trained dolphins having been deployed to defend Russia’s fleet from underwater sabotage, it’s obvious that there is more to this area than just guns and tanks. So where are managers investing in this area?
Here, we highlight three Elite Rated funds and the defence stocks they hold.
“BAE Systems and Raytheon Technologies – our two defence holdings – were among the best performers in the quarter, returning 26.7% and 15.7% respectively in USD,” said co-managers Matthew Page and Dr. Ian Mortimer in their quarterly fund update.
“BAE Systems – the British multinational manufacturer of advanced defence,
security and aerospace systems – is the largest defence contractor in Europe (by
revenue) and the third largest in the world. The company has diversified exposure to many key defence markets and programmes; strong recent share price performance therefore comes as no surprise given the rise in geopolitical tensions and the prospect of continued growth – perhaps at a faster rate – in overall global defence spending, which has grown every year since 2014 and almost doubled over the last 20 years.
“Raytheon Technologies manufactures advanced technology products in the aerospace and defence industry, including aircraft engines, avionics, aerostructures, cybersecurity, guided missiles, air defence systems, satellites, and drones. The company is the result of a merger in 2020 between United Technologies’ aerospace business and Raytheon’s defence business.
“The company is a large military contractor, receiving a significant portion of its revenue from the US government. Military exposure is sticky and subject to ultra-long contracts, in turn providing revenue visibility and reduced cyclicality (45% of revenue is aftermarket and recurring).
“Like BAE Systems, Raytheon Technologies has significant exposure to the F-35 programme – the most expensive military programme in history – as it is the sole supplier of engines for the US fighter jets. Increased defence spending arising from geopolitical conflicts aids long-term demand for Raytheon Technologies’ products and services and hence the stock price appreciated over the last quarter.”
In their latest fund update, managers Ben Leyland and Robert Lancastle highlighted their holding Thales Group, a French multinational company that provides services for the aerospace, defence, transportation and security markets as one of the strongest performers in the portfolio.
“We believe our portfolio is well placed for an environment of heightened real-world inflation and financial-market volatility,” they said. “We would highlight our large and diverse exposure to a variety of capital-cycle beneficiaries operating in areas where there has been a multi-year, and in some cases, multi-decade period of underinvestment, which now requires addressing and/or will result in significant price inflation. These include energy, infrastructure and now European defence.”
One of the fund’s best performers in March was Avon Protection, a Wiltshire-based company that specialises in the engineering and manufacturing of respiratory protection equipment for military, law enforcement and fire personnel.
“The company announced it had secured a contract worth up to $204 million to supply the US Defence Logistics Agency with an Advanced Combat Helmet,” manager Simon Moon revealed.
“Another company we added to the portfolio, which would be the beneficiary of increased military spending, is Cohort,” he continued. Cohort creates solutions to keep people safe – applying advanced technology to protect and secure. It is the parent company of six businesses providing a wide range of services and products for British, Portuguese and international customers in defence, security and related markets.
“We see that there’s been a bit of a sea change in European countries with their appetite for military spending,” said Simon. “And one way of getting access to that is through the likes of Cohort, which is really quite an under the radar company which is exposed to those revenue streams.”