Defence tech stocks in the crosshairs

Many fund managers pursuing a ‘responsible investment’ strategy have weapons exclusion policies. Some are now rewriting those policies to accommodate reality. In so doing, they are scaling back their offensive on stocks in the defence sector. It is curious, then, that other fund managers are going the other way and expanding their idea of what a defence stock is, specifically by placing some AI and ICT stocks in their crosshairs.

It is a truism that the integration of AI and tech into defence systems and weapons has increased correlation in stock prices across the AI/ICT and defence sectors. Investors are aware of this already. Long or short, they have always observed the extent of correlation across sectors.

Those in the business of divesting and excluding stocks from their portfolios for political or other non-financial reasons are also attuned to this increased correlation. They consider exposure to such AI and tech companies as giving them a problem: indirect or derivative exposure to the defence sector.

In an attempt to make this blurring of sectors appear more scientific, these fund managers have constructed for themselves numerical threshold tests. Where the income stream of an AI or ICT company from the defence sector exceeds their made-up threshold, they treat the AI/ICT stock as a de facto defence stock under their defence exclusion policies. But that air of objectivity vanishes once the reductive logic of these investment managers is probed.

Those divesting for non-financial reasons are obliged to look at sector correlation in a different way. Looking for similarities across sectors cannot be at the cost of ignoring the differences.

Even for a fund manager with an ESG or ethical policy, there may be sound reason for investing in a stock in a linked sector. The obvious example is the AI company which puts the ‘smart’ in ‘smart bomb’. If it increases precision and reduces the risk of collateral damage, it ameliorates an entire set of underlying concerns they would otherwise have. It goes the other way too. Technology has made the leap from defence to sectors such as healthcare. Attack the stock and you attack global healthcare. Followed to its logical conclusion, the linkage of an AI/ICT company to a defence company ought to give pause for thought, not expand divestment. A blunt numerical threshold test adds nothing to such an obvious analysis.

Another misstep is in how those with ethical or ESG policies fail to recognise the difference between products and the shares of AI/ICT companies. A share is not a 1:1 mirror of the products sold. A dual-use product does not create a dual-use share. There is no such thing. Between the product and the share sits the company. The company’s raison d’etre is more properly gathered from the company’s business plan and the public statements of the board than snapshots of income streams. That is particularly the case with AI/ICT companies who might face monetisation challenges in the consumer sector, which is why they are instead assessed by traction.

The apparent ease with which fund managers believe they can and should recharacterize AI/ICT stocks as de facto defence stocks is far from the idea of ‘shareholder enlightenment’. They cannot be heard to say, “my policy told me to exclude the stock”, when they write the policy. Like the actual Enlightenment, and Plato even earlier, such thinking ignores difference in the quest for some golden rule of general application. Plato would not have seen a portfolio of different stocks, just the idea of a single stock. Try managing a dynamic investment portfolio as though stocks were indistinguishable! Yet, by blurring the AI/ICT and defence sectors, some fund managers are moving in that direction.