Defense Sector on the Radar

Quick Read

• Defense spending is rising amid geopolitical fragmentation. This megaforce could shape market dynamics for years to come - yet may be underappreciated by investors.
• An active, selective approach to capturing the full spectrum of defense investments can offer alpha potential.
• Including defense exposure can enhance diversification and resilience in equity portfolios, particularly during times of geopolitical uncertainty.

Geopolitical fragmentation is driving a surge in global defense spending. This reached an unprecedented $2.7 trillion last year — an increase of 9.4% in real terms from 2023 and the steepest year-on-year rise since at least the end of the cold war. The increase in spending is widespread with over 100 countries around the world raising their military spending in 2024.¹

To put in context the relevance of defense as a theme, we compare it to another top-of-mind theme: A.I. As shown in the chart below, US defense spending comprises ~3.5% of US GDP (solid yellow line) and it is anticipated that it will reach 5% by 2035.² Investment in A.I.-related construction including data centers, electric power utilities, and computer manufacturing sites, is less than 1% of GDP (solid black line) and has already doubled since 2018.

We use proprietary text analytics to quantify attention paid to each theme and observe the attention paid to A.I. has increased by ~180% (dashed black line) whereas attention paid to defense has only increased by ~35% (dashed yellow line). This suggests investors are not yet fully appreciating the significance of defense spending and its impact on global financial markets.

Investors tracking a broad US equity index like the S&P 500 gain a mere 3.5% exposure to the theme of defense spending whereas the exposure to the A.I. theme is 32%. This suggests potential underinvestment in defense as a theme.

US GDP Spend on defense and A.I. vs. Attention Scores

Exposure to potential global defense beneficiaries can provide a valuable source of diversification. The focus on companies whose earnings have a higher dependence on long-term government contracts than the corporate capex cycle can create a less cyclical allocation to a portfolio. The chart below shows the correlation of the active returns of global defense spending beneficiaries with the Economic Policy Uncertainty Geopolitical Risk Indicator, the VIX Index, and Gold, suggesting that such companies have historically demonstrated resilience during periods of heightened geopolitical uncertainty.

The active returns of defense beneficiaries have illustrated positive correlations to VIX and gold during periods of heightened geopolitical uncertainty

The significant and steady rise in defense spending—driven by geopolitical fragmentation—is a structural theme that we believe will influence financial markets for the foreseeable future, outperforming global equities over time.

A more precise exposure and active approach can create alpha potential. We believe that an active approach which pursues exposure to the full ecosystem of defense is needed to effectively capture the investment opportunity set, and that a deep understanding of the macroeconomic drivers of defense spending is critical to stay ahead of evolutions. We focus on identifying companies throughout the full value chain of defense spending beneficiaries that can deliver on long-term earnings growth and actively managing regional and sub-theme tilts to add value.