Betting on geopolitical turmoil! American investors are flocking to buy defense stocks

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With the successive eruptions of geopolitical risks such as the Russia-Ukraine war and US-Iran conflicts, American institutional investors are accelerating capital injections into the defense industry.

According to the Financial Times, data shows that in the first quarter of this year, U.S.-listed defense sector ETFs saw a net inflow of $4.8 billion, compared to just $283 million a year ago, and net outflows two years ago.

At the same time, annual commitments by U.S. public pension funds to defense-related private equity funds have more than doubled from 2022 to 2025, while overall private equity commitments have fallen by 2% during the same period. In the first quarter of this year, commitments to defense sector funds continued to grow at a double-digit rate, while allocations in the overall private equity market continued to shrink.

Behind these fund flows is investors' re-definition of defense spending, shifting from "cyclical trades" to a "multi-year demand story."

From Cyclical Trade to Structural Theme

Matthew Bartolini, Head of SPDR Americas Research at State Street Investment Management, described the shift directly: "What happened in the past year is that we are now facing a market defined by higher geopolitical risks and less global cooperation. Defense spending has moved from a kind of cyclical trade to something with stronger multi-year demand characteristics."

The logic is not complicated: wars are ongoing, military spending is rising, orders are coming in. European defense spending surged by 60% from 2020 to 2025; in early April this year, the White House proposed a military budget for fiscal year 2027 of as much as $1.5 trillion, a substantial increase from this year's $901 billion.

External risks also reinforce this narrative. The possibility of direct confrontation between Russia and NATO, and further escalation in the Middle East—such potential conflicts have led investors to believe that higher defense spending may be structural rather than temporary. In a report last December, the U.S. Council on Foreign Relations noted: "The world is undeniably more violent and disordered. In fact, the number of armed conflicts is now at its highest since the end of World War II."

Boom in Both Public and Private Markets

Market performance has validated the judgment of these funds. Since the outbreak of the Russia-Ukraine war in 2022, the S&P Aerospace & Defense Select Industry Index has surged 142%, while the S&P 500 index rose 64% over the same period—a significantly higher excess return from the defense sector.

The private market is similarly heated. Defense-tech startup Anduril Industries, known for its AI-driven autonomous weapons and surveillance systems, saw its valuation soar from $14 billion to $60 billion in the past two years. Defense-focused private equity firm Arlington Capital Partners completed fundraising for its latest fund at $6 billion in October last year, a 57% increase over the previous fund, with nearly a dozen public pension funds participating.

The Invesco Aerospace & Defense ETF has grown from $653 million in 2022 to $8.4 billion, with the increase mainly coming from continued net inflows. The fund’s manager, Rene Reyna, said institutional interest in defense ETFs has been "tremendous" in recent months.

ESG Retreats, Defense “Unbanned”

Another driver of fund inflows is the decline of ESG investment philosophy.

Julian McManus, a fund manager at Janus Henderson Investors, recalled that leading defense companies such as BAE Systems had long been labeled as "dull, slow-growing and low-margin," while also being burdened by ESG pressures. "Three to five years ago, the mainstream view in ESG-specific circles was that all defense is bad and basically uninvestable from an ESG perspective."

Now the tide has turned. The Trump administration’s ongoing suppression of ESG topics has accelerated the marginalization of this philosophy in the U.S. market. Paul O'Brien, trustee of the Wyoming Retirement System, says bluntly: "ESG has taken a real beating in the U.S. over the past two or three years."

Kirk Konert, managing partner at Florida-based defense private equity firm AE Industrial Partners, said global instability has risen "dramatically" in recent years and defense and national security spending have become a "necessity."

Valuation Overheating Risks Emerge

With the influx of hot money, some investors are starting to sound warnings.

Reyna admits that defense stocks "appear overvalued on a growth-adjusted basis," which partly explains recent price pullbacks. Konert also warns investors not to "just chase the hottest trades and buy in at the highest prices."

In addition, some have questioned the broader economic benefits of defense investments. O'Brien offered an analogy: "You can compare this with money flowing into data centers—data centers generate revenue and output, contributing to the economy. But if you buy a nuclear submarine, missiles, or an aircraft carrier, it just sits there and you hope you never have to use it."

Risk Disclosure and DisclaimerThe market involves risks, and investments should be made with caution. This article does not constitute personal investment advice and does not take into account your individual objectives, financial situation, or needs. Users should consider whether any opinions, views, or conclusions in this article are appropriate for their situation. You are solely responsible for your investments based on this article. ```