Defense stocks in an ESG portfolio? A profound — and controversial — shift seems to be underway

Russia's ongoing war in Ukraine has resulted in a profound shift in the way defense stocks are viewed by mission-driven fund managers, according to two European defense giants.

Defense stocks have typically been excluded from portfolios based on environmental, social and governance (ESG) factors due to ethical concerns over their association with warfare.

In recent months, however, ESG fund managers appear to have become increasingly comfortable with holding defense companies — at a time of soaring industry profits and higher defense spending, as governments respond to elevated geopolitical risk.

Nonetheless, the inclusion of defense stocks in sustainably-minded portfolios remains controversial.

Micael Johansson, CEO of the Swedish defense and security company Saab, said Russia's decision to launch a full-scale invasion of Ukraine in February 2022 had brought about a "dramatic" change in the ESG debate.

"I think we had, like, 45,000 to 50,000 shareholders before this tragic war happened and now, we have, like, beyond 175,000 shareholders. Of course, the interest in investing in us is very different now, but there is still some sort of hesitation in the market," Johansson told CNBC's Silvia Amaro on Aug. 21.

Johansson said some pension funds, for example, were still unwilling to invest in defense stocks, adding that there hasn't been a sudden "all-in" approach to recognizing defense firms as sustainable businesses.

"Not everyone is viewing it that way. There is still more to do in that area, which is to me really frustrating … because if you don't have any security and a deterrents effect, then you can't talk about the ESG from other perspectives. That's sort of the foundation of sustainability in my eye," Johansson said.

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