Defence companies face ESG risks tied to carbon footprints and business ethics, but enhanced ESG clarity and rising defence budgets could boost their investability, according to Morningstar.
Traditionally, defence stocks were often excluded from ESG-focused portfolios due to their links to weaponry and conflict. However, changing global conditions are now prompting a reassessment of their role in sustainable investing,according to Morningstar’s latest Defence Landscape report.
The report identified key ESG risks for defence firms. Environmental concerns are ignificant, with defence operations and production accounting for over 5% of global emissions—a figure likely to rise as geopolitical conflicts intensify. The sector also faces challenges related to product safety, ethical supply chains, and cybersecurity. Failures in these areas could result in financial losses, reputational damage, and heightened regulatory scrutiny, according to the researchers.
Shifting perceptions of defence stocks have gained momentum in Europe, where the EU Parliament is exploring ways to make the sector more ESG-aligned. The forthcoming Social Taxonomy from the European Platform on Sustainable Finance, set for adoption in 2025, will distinguish general defence activities from controversial weapons. Companies like BAE and Thales, which have minimal involvement in banned weapons, are already phasing out materials like white phosphorus to align with these standards.
Defence spending becomes “less of a problem” – even for ESG
Despite these challenges, the defence sector’s strategic importance has led to strong performance. The Morningstar Global Aerospace and Defence Index delivered a 56.4% return from October 2021 to September 2024, outperforming both sustainability-focused and broader market benchmarks.
Human rights concerns remain an issue, the researchers highlighted. Defence companies often source raw materials from regions with weak labour protections, raising risks of forced labour and ethical violations. Cybersecurity threats also continue to grow, as these firms manage sensitive government data and deploy advanced technologies like AI-powered drones.
According to Loredana Muharremi, equity analyst at Morningstar: “Defence companies are increasingly recognised for their strategic role in maintaining security and protecting freedom. While these challenges are notable, the sector’s strategic relevance and ongoing compliance efforts signal a recalibrated approach to assessing the sustainability credentials of defence stocks.”
