The investment shift is hardly surprising: European financial markets soared this month in response to Germany's announcement – coinciding with recent federal elections – to bolster defence spending. The EU plans to unlock nearly €800 billion ($873 billion) to bolster security as the US has suspended military aid to Ukraine and turned up pressure on the Ukrainian government to reach a peace deal.

According to news breaking out early evening yesterday in Europe, State Secretary Marco Rubio said the US made an offer, which the Ukrainians have accepted, "to enter into a ceasefire and enter into negotiations to end this conflict in a way that is enduring and sustainable." As of the time of this story going live, talks continued. Western security officials said Russian President Vladimir Putin has no intention of compromising on demands on land, peacekeepers and Ukraine’s neutrality in any peace talks, complicating President Donald Trump’s efforts to secure a credible settlement (Source: Bloomberg, 11 March.)  

As if to highlight how defence has become an urgent investment topic in Europe – possibly at odds with ideas about ESG investing – yesterday launched a new exchange-traded fund,: The WisdomTree Europe Defence UCITS ETF (WDEF), listed on Börse Xetra, Borsa Italiana and the London Stock Exchange.

“Defence and security are underrepresented in many portfolios and have faced decades of underinvestment in Europe, resulting in a significant capability gap. A structural shift is underway in Europe as nations increase defence budgets to meet NATO targets and respond to geopolitical challenges,” Pierre Debru, head of research, Europe at WisdomTree, said in a note.

After years of being scolded by President Trump for not spending enough in percentage terms on defence, Europe is moving, so governments say. The EU's “Rearm Europe” package involves the activation of the national safeguard clause of the Stability and Growth Pact, enabling EU countries to increase their defence spending by an average of 1.5 per cent of GDP, or €650 billion that could be released over the next four years. It also entails a "new instrument" to provide €150 billion in loans to member states to finance joint defence investments in pan-European capabilities.

In Germany, Europe's largest economy, Berlin proposes to exempt defence from a budget restriction; it will launch an off-budget infrastructure fund of €500 billion over the next 10 years. That sum equates to about 1 per cent of GDP a year. The money can be used for civil and population protection, transport, energy, education, care and science infrastructure, in addition to hospital investments and research, and digitisation. The German federal states can also have a structural deficit of 0.35 per cent of GDP a year, from the current nil figure in percentage terms, equivalent to about €15 billion euros. Other European nations are taking similar action; UK Prime Minister Keir Starmer is also throwing his weight behind Ukraine and defence spending is set to rise.

Stocks of European businesses linked to this spending are rising. For example, shares in Rheinmetall, the German automotive and arms manufacturer, have risen, along with those of Britain’s BAE Systems and Paris-listed Thales. All of a sudden, defence is a hot area. Over the past year, Europe defence stocks rose 40.8 per cent, outpacing broader European equities at +11.4 per cent, according to Aneeka Gupta, director, macroeconomic research at research economists Niklas Garnadt and Filippo Taddei think the sharp rise in EU defence spending over the next two years will have a positive but limited impact on GDP growth.

Milali argues that concerns about rising debt issuance are exacerbated by discussions to encourage other European countries to increase their defence spending as well. “While Germany can afford such a stimulus plan without its debt trajectory becoming unsustainable (the debt-to-GDP ratio should only reach 68 per cent by 2028), doubts are more acute when it comes to France and the peripheral countries,” Milali said. “In any case, the face of Europe has definitively changed, and this paradigm shift will have lasting consequences on bond markets, with equilibrium levels being structurally revised upwards.”

Jon Cunliffe, , prefers the idea of German chancellor-in-waiting Friedrich Merz of increasing infrastructure spending. “Unlike nuclear warheads, which hopefully would never be used, infrastructure investments have long-term benefits and are a foundation for sustained economic growth and development,” Pyshkin said. “For example, Germany could restart its nuclear power plants, securing lower energy electricity prices for industry, thus improving its competitiveness,” Pyshkin said.

Pyshkin prefers to see infrastructure rather than defence investments in Europe as that would ensure long-term competitiveness of the economy. “In contrast, defence will only provide a short-term boost to certain sectors but may increase the borrowing costs, negating the benefit,” Pyshkin said.

This news service is assessing the relationship between defence stocks and ESG-focused portfolios and where they sit together. In 2022, a few months after Russia's invasion of Ukraine, we wrote about how the boundaries of ESG are being shifted by the need to equip countries in their defence.

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