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The increase in flows coincides with a rise in defence spending by European governments that many in Europe and the US have decried as being too slow © Reuters

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European investors appear to have overcome a traditional reluctance to invest in the defence sector and are pumping money into locally domiciled defence exchange traded funds.

Net flows into the three available ETFs since the beginning of this month had already amounted to $189mn by April 22, according to data from ETFbook, which puts it on track to echo the record haul of 321mn that the three funds pulled in in March.

The increase in flows coincides with a rise in defence spending by European governments that many in Europe and the US have decried as being too slow. The investors may stand to benefit if European nations continue to boost military spending.

Retail investors own about 60 per cent of the largest fund, the VanEck Defense Ucits ETF (DFNS), according to Martijn Rozemuller, chief executive of VanEck. But he said wealthy clients of private banks, family offices and independent wealth managers were partly behind the boom in investment seen since February.

Rozemuller described an altercation at a recent presentation for wealthy clients which seems to point to a change in mood in Europe: “Some people in the audience were wondering why we screened for controversial weapons, when the Russians don’t seem to care about using them.”

Column chart of Monthly flows ($mn) showing Investment booms in European-listed defence ETFs

VanEck is hoping to exploit this mood by aiming to attract one of the largest sources of untapped capital — pension funds.

“We’re trying to plan an event [explaining our defence ETF] for pension funds in the Netherlands which we might extend to other countries too,” said Rozemuller.

“We read a lot of comments in the papers about politicians and members of our government that urge the financial industry as a whole, and pension funds in particular, to rethink their investment policy when it comes investing in the defence industry,” he added.

Pension funds in Europe have traditionally excluded defence stocks, which generally fall foul of environmental, social and governance (ESG) filters.

Tom Bailey, head of research at HANetf, issuer of the second-largest defence ETF, the Future of Defence Ucits ETF (NATO), said flows were being driven by two main factors.

“We are seeing clients buy the NATO ETF as a hedge against geopolitical risk. But many clients are also buying on the basis of the long-term structural story,” said Bailey.

“The rearmament of Europe as well as a wider pick-up in military spending among the US and its Asia-Pacific allies is receiving growing recognition as a key macro theme.”

Bailey said HANetf had been having conversations “at a number of levels” on NATO, including with pension funds.

The ETFs have been delivering solid returns. Investors who bought into DFNS at the end of September last year will have benefited from a 35 per cent rise in its share price by the end of March and more than 50 per cent had they held it for a full 12 months, according to ETFbook. NATO investors were similarly well rewarded, chalking up a 37 per cent rise in the six months to the end of March.

“Having long excluded defence stocks from their portfolios, there has been a lot of soul searching among pension plans lately,” said Amin Rajan, chief executive of Create-Research, a consultancy that regularly surveys pension funds globally.

“As a belligerent neighbour, Russia poses a threat to security and order in Europe. This is changing the context in which ESG standards are being reinterpreted,” he said, adding that defence stocks were no longer being seen as pariahs. “The context matters,” he said.

He added that the issue had become all the more pertinent because pension funds had missed out on the bounce in defence stocks.

“It remains to be seen how this translates into increased allocations,” he added.

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