It has been a particularly interesting few months in the European defence industry, so we thought it was interesting to look a bit into what is happening there. First of all, we think that there is a fundamental paradigm shift going on in European defence. After the collapse of the Soviet Union in the early 1990s, defence spending in Europe was really tumbling down the priority list for politicians, but also the electorate. On top of that, investors put the defence industry into the penalty box, because it was deemed non-compliant with ESG requirements.

Now I would say roughly two years ago, all of this started to be put on its head. We had heightened geopolitical tensions; we have now unfortunately have a war in Europe; we have a possible return of Trump to the White House, and question marks around the long-term viability of the NATO construct. So it was clear that Europe had to change its approach to defence. And we have seen a reaction. One stat says, for example, in 2024, 18 of the 31 NATO countries will actually honour their 2% spend as a percentage of GDP. In 2016, there was five countries only honouring that.

So, has the problem been fixed? Has it been addressed? Well, I think we are actually only at the foothills of a multi-decade long investment cycle into defence. Thirty years of chronic underinvestment cannot be fixed overnight. Various bodies look at the situation and they say that the underinvestment in Europe has been accumulating to something like US$600 billion. So even spending 2% of GDP might not be enough to catch up in a timely manner.

So we cannot forecast the geopolitical twists and turns; but it is very difficult to come up with a picture [where investment] will not continue to go up in the coming years. Looking at it [through] a more conventional investment lens, defence stocks have rallied in the last two years, because of this input outlook. However, valuations remain reasonable. The sector more or less trades in line with the overall industrial sector – that is quite interesting given the very positive close outlook I just mentioned. On top of that, the sector remains fragmented, so consolidation provides some upside optionality.

A third point would be that defence is one of very few sub-sectors where the outlook in Europe for earnings is probably better than in the US, and that makes it very interesting from a European equity perspective.

And then the last point I would make is that investor acceptance is growing; and I will just borrow here a phrase by the CEO of Euronext, a pan-European exchange. He said last week: “There is a new brand of ESG making the rounds, and that is for energy, security and geopolitics”. So, plenty of investors still to come into this space.