Sustainable investors appear to be more comfortable with defense stocks.

Russia’s ongoing war in Ukraine has prompted a major shift in how mission-focused fund managers view defense stocks, according to two European defense giants.

Defense stocks are often excluded from portfolios due to environmental, social, and governance (ESG) factors, due to ethical concerns related to war.

But in recent months, ESG fund managers have seemed increasingly comfortable owning defense companies, as industry profits surge and defense spending rises as governments respond to rising geopolitical risks.

Nonetheless, including defense stocks in portfolios that take sustainability into account remains controversial.

Mikael Johansson, CEO of Swedish defence and security company Saab, said Russia’s decision to launch a full-scale invasion of Ukraine in February 2022 had brought about a “dramatic” shift in the ESG debate.

“Before this tragic war, we had, I think, 45,000 to 50,000 shareholders. And now,, good night, “We have over 175,000 shareholders. Of course, there is a lot of interest in investing in us right now, but there is still some hesitation in the market,” Johansson told CNBC’s Silvia Amaro on Aug. 21.

Johansson added that some pension funds, for example, are still reluctant to invest in defense stocks, and there is no sudden “all-in” approach to recognizing defense companies as sustainable businesses.

“Not everyone sees it that way. There’s still a lot of work to be done in that area, and I find it really frustrating… if there’s no security and deterrence,, “Then you can’t talk about ESG from a different perspective. In my eyes, that’s the basis of sustainability,” Johansson said.

Shares of Saab, which produces missiles, submarines and fighter jets, have soared since the start of the war between Russia and Ukraine. They rose by about 330% between February 20, 2022 and August 29, 2024.

“Traditionally, ESG investors, especially retail investors, don’t want to be associated with companies that produce weapons,” Ida Kassa Johannesen, head of commercial ESG at Saxo Bank, told CNBC in a video conference.

“Ultimately, (these are) the companies that are causing the deaths and innocent victims in the Middle East right now, in wars in Africa, for example in the Democratic Republic of Congo, and in wars in several other parts of the world. Retail investors don’t want anything to do with these types of companies.”

Johannessen said this made it common for fund managers to be reluctant to include some defense stocks in their portfolios to avoid questioning from clients.

Asked whether defense companies should do more to improve their reputations, Saab’s Johansson said: “Probably, I don’t know. I don’t think I would have worked for this company for 39 years if I wasn’t extremely committed to what we do, what we really stand for and what we contribute in terms of resilience and excellence.”

Johansson said it was essential to have a “professional” and “serious” company that could provide the resources needed for the defense force if politicians were to recognize the threat environment.

“So, we stand for something that’s really important. And I don’t have any issues with our reputation. I don’t know about other people,” he added.

ESG investing has become a polarized political issue in recent years, particularly in the United States.

Republicans have characterized mission-driven investing as a form of “woke capitalism” that prioritizes liberal goals over financial returns.

Democrats have pushed back, describing the attacks on a range of ethically responsible business practices as “attempts to foment a culture war and protect corporate special interests,” according to the Democratic Oversight and Accountability Committee.

Analysts expect the outcome of the U.S. presidential election in November to determine whether the political backlash against ESG will have a deep and lasting impact.

“Before Ukraine, we couldn’t have that conversation, even though we were doing a great job at E, S and G, because we couldn’t talk about it,” said Brad Greve, chief financial officer of the UK defence group. BAE SystemsHe said this in an interview with CNBC on August 14:

“What’s happened since Ukraine is there’s been a real change in attitude. I think people have now reflected. It’s really important to see what role defense companies play in protecting free societies,” he said.

Greve said fund managers always have the right to invest as they see fit, but “what’s great about it now, from my perspective, is that we can have a conversation about the positive role we play in society.”

Shares of BAE Systems, which builds nuclear-powered submarines and fighter jets and supplies military equipment, rose about 130% between February 20, 2022 and August 29, 2024.

Saxo Bank’s Johannessen said the ongoing war between Ukraine and Russia had fuelled the ESG debate, but most fund managers remained “fairly cautious” about investing in the defense sector.

“Should we put them all in the same bucket? It’s a mix. It’s a mix of different types of companies. There are big bad guys, and there are bad guys that aren’t so bad,” Johannesen said.

“It’s not easy to say, ‘Just because someone produces weapons, they’re a villain.’ That’s not my decision, and I don’t think retail investors should be making those decisions for other people. They should be making their own decisions, but they shouldn’t be trying to demonize every company that produces weapons, for example,” she added.