Key takeaways
- European ESG funds have significantly increased their defense exposure since Russia’s full-scale invasion of Ukraine in 2022.
- The European Commission and ESMA emphasize that sustainable funds can include defense companies under certain conditions.
- Asset managers remain divided over definitions, implications of dual-use technology, thresholds and risks of including weapons makers in their portfolios.
Just as world leaders contend with a crumbling global order, investors are rethinking the role of defense companies in portfolios with an environmental, social, and governance focus. When the Sustainable Finance Disclosure Regulation came into effect back in March 2021, defense companies were certainly not what markets had in focus. Fast-forward to July 2025, and the continent is struggling to reconcile sustainability goals with security imperatives.
Since Russia’s full-scale invasion of Ukraine in 2022, exposure of ESG European equity funds to aerospace & defense (A&D) has increased by a factor of 2.7 on average, says Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics. This trend has further accelerated following the announcement of the “ReArm Europe” plan earlier this year.
According to Morningstar data, around 43% of ESG European equity funds now hold some A&D exposure, narrowing the gap to non-ESG funds, which have an exposure of 56%. “While we haven’t seen much increased exposure to defense among Article 9 funds, which represent only 4% of all EU funds, defense exposure has grown among Article 8 funds,” Bioy says.
Article 8, or ‘light green’ funds promote environmental or social characteristics, while the stricter Article 9, or ‘dark green’ funds are required to have a sustainability objective and adhere to stricter disclosure standards. Article 6 funds, on the other hand, do not promote ESG characteristics or pursue sustainability objectives under SFDR.
What Does the EU Say About Defense in ESG Funds?
This evolution reflects not just a growing investor appetite for well-performing defense stocks, but also a recalibration of regulatory interpretations, with the European Commission clarifying that the SFDR does not preclude investment in defense.
In a recent notice, the Commission emphasized that “the EU sustainable finance framework is compatible with investing in the defense sector.” Sustainability disclosures apply “horizontally across all industries” and the framework “sets no limitations on the financing of any sector, including the defense sector.” Each investment should be assessed individually, not dismissed based on industry classification alone.
This clarification is crucial, says Morningstar’s Bioy: The Commission wants to remove any doubt that sustainable funds can, under certain conditions, include defense companies.
Nobody Wants to Miss Out on the Defense Rally
The sector’s recent rally has proven to be a powerful lure to fund managers. European defense stocks have surged since 2022, and ESG funds have taken notice. Active ESG European equity funds have led this trend, tripling their exposure to the sector over the past three years. As of March 2025, these funds had an average allocation of 1.9% to A&D stocks, compared to 2.3% in non-ESG funds. The once-significant gap between ESG and conventional strategies has narrowed.
Passive ESG funds allocate just 0.6% to the sector, compared with 1.7% for non-ESG passive peers. Still, this represents an increase over previous years. For context: The A&D sector currently represents about 4% of the Morningstar Developed Europe index, up from 1.5% three years ago.
The change is partly performance-driven. Shares of companies like Rheinmetall, Saab, and Leonardo have soared since early 2022. “Looking at performance, it’s clear that excluding or underweighting the defense sector has penalized returns. And we’re seeing this for both ESG funds and non-ESG funds”, Bioy says.
But the increase in exposure is also driven by fund managers proactively buying more shares, she adds.
Some Weapons Are More Controversial Than Others
Despite this trend, fund managers remain cautious about so-called controversial weapons. The EU Defense Omnibus Package and financial markets regulator ESMA still hold that anti-personnel mines, biological and chemical weapons, and cluster munitions are controversial weapons and incompatible with sustainable investing.
“Article 8 and Article 9 funds commonly exclude controversial weapons. But military weapons - those used by state defense forces - are generally not excluded”, Bioy says.
Definitions vary: Some asset managers exclude any company involved in nuclear weapons, while others allow holdings in firms based in countries that are signatories to the Nuclear Non-Proliferation Treaty (NPT). There are further distinctions based on whether a company manufactures entire weapons or merely supplies components or logistics.
There are no exchange-listed companies in Europe that are involved in the manufacture of non-nuclear controversial weapons such as chemical weapons or anti-personnel mines. Airbus AIR and Safran SAF, whose joint venture ArianeGroup manufactures nuclear-capable missiles for France, benefit from their home country’s status as an NPT signatory state.
“Involvement in both controversial weapons and military contracting has increased in Article 8 funds by a factor of 2.4 and 2.6, respectively, since 2022,” says Bioy. “Still, their involvement is about half that of Article 6 funds.”
Article 9 funds have shown little change in their exclusion policies or levels of exposure. That is not to say that there are no Article 9 funds with aerospace and defense exposure. Using data from Morningstar Sustainalytics, Bioy and her team identified 17 Article 9 funds in the European equity category that hold defense stocks. These include funds with climate, impact, and social mandates.
“Dual-use technologies are another gray area,” Bioy adds. “Technologies like AI, satellite systems, or propulsion can have both civilian and military applications. Whether these count toward exclusion depends on how strictly a fund defines involvement.”
How Do Weapons Makers End Up in Sustainable Funds?
European asset managers are adapting their approaches. DWS and Allianz Global Investors have formally outlined why certain Article 8 funds can now hold defense stocks- while keeping exclusions for controversial weapons.
DWS differentiates between Article 8 funds that merely disclose ESG characteristics and those that carry ESG in their name or branding. “For funds that apply the ‘DWS ESG Investment Standard,’ we exclude companies that generate more than 5% of their revenues from defense products or are involved in nuclear weapons or depleted uranium,” the firm states. “This policy remains unchanged.”
However, other Article 8 funds follow a basic exclusion filter, which was recently revised to allow companies with up to 10% revenue from defense, and firms involved in nuclear weapons within the NPT framework.
Similarly, Allianz Global Investors adjusted its Article 8 policy. In March 2025, it announced changes allowing defense companies to be eligible for inclusion in funds that meet AllianzGI’s binding sustainability criteria.
“With the France-domiciled Allianz Actions Euro Innovation fund, AllianzGI already offers an Article 8 fund that invests in defense companies. Other Article 8 funds will adjust their investment policies during the third quarter of 2025,” AllianzGI told Morningstar.
“With stretched fiscal budgets across Europe, we believe private capital must play a role in financing a resilient defense system,” AllianzGI says. “Our goal is not only to support this transition but also to guide companies toward more transparent disclosures and responsible practices.”
Helaba Invest takes a more restrictive line. “The goal of defense is not a sustainable end in itself. Therefore, defense cannot be considered a sustainable characteristic of an Article 8 fund,” says Katharina Drexler, sustainability officer at Helaba Invest.
“That does not mean that arms are excluded entirely: if, for example, no controversial weapons are involved, a defense title may be included in one of our Article 8 funds - as long as the 25% threshold for sustainable investments in the fund is not exceeded.” The 25% threshold refers to the portion of a fund’s assets that a manager designates as “sustainable investments” under the SFDR.
Drexler adds that institutional clients often have their own definitions and expectations when it comes to ESG, especially church-based or public-sector investors. A core issue is the definition of what actually constitutes a “defense company,” she explains, echoing concerns of dual-use firms that produce technologies with both civilian and military applications, such as in electronics, engineering, or aerospace.
“Since capital market investors typically invest in the company as a whole, not in isolated business units, it’s often impossible to separate out the defense exposure,” Drexler says. In such cases, the percentage of revenue derived from defense becomes a key factor in the ESG evaluation.
Unclear Data and Definitions Muddy the Waters of Defense Investing
Another difficulty lies in classifying weapon types according to how unethical they are. “There is general agreement to exclude companies involved in the production or sale of internationally banned weapons,” she says. “But terms like ‘controversial weapons’ - such as nuclear arms or autonomous systems - are less clearly defined, which causes uncertainty.”
Reputational risk and data quality also remain major concerns, she adds.
As Bioy says, “it’s fair to say that investors will remain divided on whether defense is compatible with sustainability objectives and many sustainable funds, especially those focused on positive impact, will continue to be underweight in the defense industry.”
Some investors see financing European defense as both a social responsibility and a source of long-term returns, while others will continue to argue that defense is fundamentally incompatible with sustainable investing.
