Outlook for Institutional Investments in the Defence Industry

Mr Catechis gave an overview of the worldwide defence industry and the investment case for pension funds.

For the next 10 years the NATO countries, excluding the US, will spend 500 – 600 billion euro annually to restore the lagging defence investments. Defence budgets of NATO countries are increasing. For example Poland is investing 3% of its Gross Domestic product on defence.

A recent NATO poll under 30,000 members of the population of NATO countries showed an increasing percentage under the population - up to 40% in the Netherlands – in favour of more defence investments. This suggests that pension plan participants may also want to see more investments made by their pension funds in the growing defence industry.

An obstacle for state funded defence is the worldwide increasing governement debt and the annual servicing costs. In addition, shrinking populations generate less tax income to invest in defence. Private markets offer a solution.

For example, investing in listed stocks of defence companies is often a suitable investment for pension funds. As is investing in fixed income through bonds issued by defence companies. Another option is to invest in real assets such as a shipyard for frigates. Private equity and venture capital type investments often invest in dual use technology, whereby technology can be used in both the civilian and the defence sector. An example is the development of drones, which can be used for reconnaissance in enemy territory, or to locate survivors of an earthquake.

For private investments ESG may be an obstacle if the defence sector is viewed from a strictly environmental point of view. If, however, security is taken into account, ESG may not be an obstacle at all. This is for pension funds to decide on.

Investing in security: a pension fund trustee perspective

Mr Heemskerk addresses the issues surrounding the decisionmaking process whether or not to invest in defence, including ESG, risk apetite, and political allignment of pension fund trustees.

For one, pension fund trustees may offer ethical objections such as civilian casualties during war. Other trustees may object against the press reporting on these investments, or worry about pressure groups occupying their offices once it is known the pension fund invests in the defence industry. Other trustees object against the defence industry because of the negative environmental impact: war emits so much C02 that it cannot be matched by C02 positive investments. In addition, defence must fit into the investment beliefs a pension fund has got.

Many pension funds view it as their mission to create a better world. What constitutes a better world exactly, and how that is achieved, implies political views of pension fund trustees. Pension funds trustees must allign on their politicial view or no policy can be made.

Defence must also fit within the risk budget, which consists of risk, retrun, and impact.

The process of discussing ethical objections, fear of pressure groups, environmental objections, suitability given the investment beliefs, ESG considerations and political allignment of trustees may take years, Mr Heemskerk expects.

Building Market Knowledge on the Defence Industry

Mr Hoeve is the managing director of MarketForecast, a specialised company that provides data analytics for the defence industry. A pension fund that consider to invest in defence needs the objective facts to make the right decisions, for which data analytics are useful.

The defence industry needs more capital. The European Defence Agency has has called upon banks to change their position of their reluctance to finance defence companies, given the growing need for more production.

There are many defence data available, from  public sources such as governements, and from defence companies. These data cover the various sections within the defence industry, from cyber weapons to submarines. Data are distributed over the categories:

• Market technology
• Country analysis
• Company analysis
• Market participant analysis

The analysis is then used as input to buid various scenarios for the short and long term, for users to be able to make informed decisons.

Investing in Defence

Mr Houwer presents the Exchange Traded Fund that VanEck developed as a means to invest in the defence industry.

VanEck created a defence ETF which has been very successful thanks to the growing industry. Also, there is growing support from the public opinion to invest more in defence, accoring to a recent NATO poll under 30,000 inhabitants of NATO countries.

VanEck invests in companies with a minimum of 50% of revenu coming from defence acitivities. Each stock may form up to a maximum of 8% of all the defence stocks combined. Cyber security, communications, training and simulation are also regarded as defence activities.

With growing support of public opinion to invest in defence, the VanEck defence ETF may be an easy solution for pension funds.