From Exclusion to Engagement: The Evolving ESG Lens on Defence

 

Reconciling Ethics with Pragmatism 

When it comes to sustainable investing, some lines are clearly drawn. Tobacco and coal, for instance, are typically excluded without controversy—their long-term societal harms are well documented, and their business models are increasingly seen as untenable. But defence has always been harder to categorise. For some investors, even conventional weapons manufacturers were seen as fundamentally incompatible with the “S” in ESG. The underlying belief: that any enterprise producing lethal equipment couldn’t credibly claim to support social responsibility.

That assumption is now under growing pressure.

Russia’s invasion of Ukraine, escalating tensions in the Indo-Pacific, and a broader rethink of what defines a sustainable society have all prompted a shift in the conversation. National security, once viewed strictly as a state responsibility, is now being re-evaluated as a shared societal good. If defence underpins economic, political, and humanitarian stability, then should it remain excluded from the sustainability conversation?

At ILIM, we’ve taken a pragmatic stance. We don’t automatically exclude defence companies from our sustainability strategies—but we do apply strict criteria, which results in the exclusion of some defence companies – including a clear assessment of exposure to controversial weapons. In an increasingly uncertain world, nuance and context matter more than ever.

 

“To be prepared for war is one of the most effectual means of preserving peace.” - George Washington 

 

Real-World Dynamics

Europe’s rearmament push — anchored by an €800 billion German defence initiative — and the United States’ renewed focus on NATO have redefined defence spending as a pillar of social resilience. The EU is now considering changes to its lending frameworks and sustainable finance taxonomy to broaden access to capital for defence firms. ESG indices are adapting too: Euronext has adjusted its CAC 40 and MIB ESG criteria to loosen exclusions related to defence, while also launching new index products centred on energy, security, and geopolitics. 

Investor sentiment has followed suit. The Stoxx European Aerospace & Defence ETF is up 67.72% year-to-date, far outpacing broader European market benchmarks such as the Stoxx 50 which is up 10.24% over a similar period.  Over a dozen European defence ETFs have launched since early 2024, collectively attracting $6.2 billion in capital so far in 2025, compared to just $1.1 billion in the same period two years prior.¹

 

The Evolving ESG Lens on Defence

What we’re seeing now isn’t opportunism—it’s evolution. Asset managers and ESG rating agencies are updating how they assess defence firms. A “tiered materiality” approach is gaining ground—evaluating companies based not just on what they produce, but how they operate: emissions efficiency, governance quality, disclosure practices, and involvement in dual-use technologies. The same principles applied to utilities or energy companies are now being applied here.

Stewardship, too, plays an important role. Rather than defaulting to divestment, more investors are opting for active engagement—encouraging transparency, cleaner supply chains, and better governance. It’s a shift that reflects the core ESG principle: driving progress through dialogue, not distance.

This isn’t a carte blanche for the defence sector. It’s a recognition that simplistic exclusions don’t always align with complex realities. At ILIM, we’ve long embraced a differentiated, principle-based approach—defence firms may be included, but only when their business practices meet acceptable sustainability and ethical standards. And our stewardship team is working daily with portfolio companies, including defence, to drive resilience into their businesses and risk adjusted return outcomes for our clients.

A Moment of Realignment 

ESG was never meant to be rigid. It’s a living framework designed to help investors navigate the intersection of capital and the real world. And the real world, at this moment, is resetting its priorities. 

Sustainable investing is about reconciling ideals with outcomes. Resilience, stability, and credible deterrence aren’t fringe concerns—they’re foundational to a just and functioning society. A principled approach to defence—grounded in transparency, active stewardship, and alignment with client values—can reflect national purpose without compromising moral clarity.

That’s not a retreat from ESG principles. It’s an acceptance that nuance is essential in a complex world.