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UK investors have reduced their holdings in some of Britain’s leading defence companies since Russia’s invasion of Ukraine last year, underlining concerns in Westminster that the sector lacks support in the City of London.
Fund managers based in the UK have cut their holdings in companies including BAE Systems and Qinetiq by an average of 9 per cent since the start of 2022, according to data from the London Stock Exchange Group.
By contrast, EU investors increased their ownership of British defence groups by 9 per cent while raising exposure to European companies by 4 per cent.
The UK government has blamed environmental, social and governance (ESG) guidelines for acting as a barrier to investment in the sector.
Britain’s City minister Andrew Griffith and defence procurement minister James Cartlidge have warned that the UK’s long-term security is being put at risk as a result.
Kevin Craven, chief executive of ADS Group, the UK industry trade body, said: “Overcautious or misapplied ESG considerations are drastically impacting the ability of the defence sector to secure financial services vital to delivering the UK an advantage.”
ADS said it was aware of “strong anecdotal examples” of lenders withdrawing banking facilities or not extending loans to small and medium-sized companies owing to their involvement in defence.
Investors are also sensitive about defence companies’ work on nuclear weapons programmes.
But sustainability experts and defence industry figures played down the role of ESG in investment decisions.
The same UK investors have increased their exposure in EU-based defence companies Dassault, Thales, Leonardo, Hensoldt, Rheinmetall, Saab, Safran and Airbus by 27 per cent in the same period, according to the LSE figures — suggesting that ESG factors are not acting as a deterrent against the industry globally.
Lindsey Stewart, director of investment stewardship research at Morningstar, said persistently low valuations in the London market were a factor.
UK equity markets have been trading at a price to earnings multiple of 10, compared with 15 for the rest of Europe and 21 for the US, according to Morningstar. “That issue requires extensive market reform. It won’t be solved by finding fault with investors’ perceived ESG preferences,” he said.
EU and US investors may be keener on UK defence shares than British investors because of the pound’s relative weakness, making UK stocks look like “bargains” from abroad, said Michael Field, an equity market strategist at Morningstar.
He also said investors on the continent had an “elevated level of awareness” about the war in Ukraine and the need to boost defence spending compared with those in the UK.
Some in the defence industry said Russia’s aggression towards Kyiv had helped woo previously cautious investors.
“Before the war in Ukraine there were elements of the London market in particular that were shying away from defence under ESG grounds, particularly over things like our involvement in the UK nuclear deterrent,” said Charles Woodburn, chief executive of BAE Systems, last week.
“The pendulum is now swinging to a more balanced position of ESG considerations coexisting with the need for defence and security.”
BAE’s UK shareholder base has been getting smaller for some time, with a swing of about 20 per cent out of the UK towards North American investors over the past five years. North American investors account for about 42 per cent of the company’s shareholders.
Although ESG investing rules generally bar involvement in weapons aimed at causing indiscriminate harm to civilians, such as cluster bombs or chemical weapons, there are few blanket exclusions on defence companies, according to experts.
“The ESG view on defence companies has always been nuanced rather than inherently negative,” said Mirza Baig, global head of ESG investments at Aviva Investors.
The Investment Association in the UK said its members were among the “largest shareholders of aerospace and defence companies, with just over £20bn invested” in them.
“We recognise and value the importance of the aerospace and defence sector for the security of the UK and its allies,” it said.