Defense stocks were once considered socially unacceptable investments, but fund managers are slowly changing tack as the sector has rallied in recent years. Europe’s aerospace and defense sector has jumped 24% since the beginning of the year, with the recent surge tied to increased geopolitical volatility. In early March, the European Commission proposed an 800-billion-euro ($878.3 billion) increase in defense spending . The move came after the U.S. halted all military aid to Ukraine amid a public spat between newly elected White House leader Donald Trump and Ukrainian leader Volodymyr Zelenskyy, with the EU saying the funding could mobilize Europe to “massively step up” its support for Ukraine. “In 2021, defense was classed as a socially unfriendly or unacceptable investment,” Ben Heelan, EMEA head of aerospace and defense research at BofA, told CNBC. “Russia’s invasion of Ukraine and what we’ve seen over the last three years is the changing narrative around defense, which is that actually it’s a good thing to have a strong, well-financed, invested defense industry.” An ESG-friendly investment? The aerospace and defense sector surged 37% in 2023 after Russian launched its invasion of Ukraine in 2022 and has continued to make gains. Heelan said the changing views on defense have been bolstered by European leaders promoting a “peace through strength” narrative. In fact, 94% of wealth managers viewed defense stocks as environmental, social, and governance (ESG) friendly, according to a 2024 survey of 50 wealth managers in Europe by ETF provider HANetf. Tom Bailey, HANetf’s head of research and content, said Russia’s invasion of Ukraine in 2022 played a pivotal role in fund managers’ reassessment of the view that defense stocks should be excluded from ESG funds. “If you’re talking on an ESG social responsibility perspective, the ability for countries to defend its borders against external aggression is something important, and so you can’t necessarily just exclude it on that basis,” Bailey told CNBC in an interview. “Is it socially responsible to have a defense sector starved of capital and not able to provide an offering in a way to ensure a strong national defense?” Micael Johansson, CEO of the Swedish defense and security company Saab , told CNBC in September that before the Ukraine-Russia war, it had 45,000 to 50,000 shareholders. That number swelled to beyond 175,000 after the war’s onset. But although fund managers are eyeing defense stocks, “die-hard ESG fans are not moving,” said Ida Kassa Johannesen, head of commercial ESG at Saxo Bank, as some retail investors still feel uncomfortable about being exposed to companies that produce equipment that ultimately kill people. However, as defense stocks continue to perform well, a number of defense-themed funds have emerged, ranging from HANetf’s Future of Defence to VanEck’s DFNS and WisdomTree’s Europe Defence ETF . NATO screenings, controversial weapons Fund managers are screening defense stocks to make them more palatable to investors. HANetf’s Future of Defence ETF, launched in July 2023, only provides exposure to defense firms based in NATO member countries. “In our ETF we use a NATO screen, so only companies domiciled in NATO member states or NATO allied countries can be included,” Bailey explained, saying the companies in HANetf’s fund only supply countries that they don’t expect to act in an aggressive manner. “We view the NATO alliance as a defensive alliance as it’s not geared towards external aggression,” he added. Some funds, such as VanEck’s DFNS and Dutch asset manager Robeco’s equity funds, apply a Controversial Weapons screening — based on a United Nations convention created in 1980 — to exclude companies involved with cluster munitions, biological and chemical weapons, white phosphorous, and nuclear weapons, among others. “These exclusions recognize the significant human rights concerns associated with such weapons while also ensuring that a broader range of investors—particularly those with strict internal ESG guidelines—can allocate capital to defense companies within an ethically and legally acceptable framework,” Martijn Rozemuller, VanEck’s Europe CEO, told CNBC in an emailed statement. Some 46 companies were eligible to be included in the DFNS index, but 18 were excluded based on VanEck’s criteria, including some of the biggest players like Britain’s BAE Systems and German arms manufacturer Rheinmetall because of their involvement with controversial weapons, VanEck said. Rozemuller noted that defense is no longer just a military concern but an “essential component of sustainability” that protects the democratic and economic systems of a country. “While ESG frameworks continue to evolve, it is clear that national and global security are fundamental to achieving sustainable economic growth and long-term prosperity,” he added. Robeco said in its latest report published in March that its controversial weapons screening and exclusion of companies involved in activities classified as unsustainable aims to counter a “natural reluctance” to invest in the defense sector given its closeness to undesirable conflicts. ‘A necessary evil’ As defense companies play an ever-increasing role in the geopolitical landscape , Saxo Bank’s Johannesen says the strong performance is likely to continue. “More and more people, including investors and ESG investors, are realizing that defense funds might just be a necessary evil. We might not like it, but we cannot do without it,” she told CNBC in a call. Robeco, for example, said its most sustainable funds don’t include defense stocks. “In other words: investing in defense can be responsible, but not sustainable,” Carola van Lamoen, head of sustainable investing and a managing director at Robeco, said in the firm’s report. But for investors who want to cash in on defense, and feel shy about going all in, there are many “non-lethal support industries that back armies and their infrastructure,” including military uniform suppliers, logistics firms, satellite technology and cybersecurity, according to Robeco. “Modern warfare also isn’t just on the battlefield, as seen when a North Korean hacking team allegedly stole over USD 1 billion worth of cryptocurrency ,” the firm said. HANetf’s Bailey said its Future of Defense fund also includes a cybersecurity component that is “slightly different than the traditional defense company” in that the typical buyer for defense equipment is the government, but the typical buyer of a cybersecurity firm could be private enterprises. Johannesen explained that as the likelihood that “countries might find themselves entangled in war” increases, investors are going to view defense as necessary, even if they don’t see it as a good thing.