In 2017, a group of individuals from the defense industry and financial sector gathered to discuss a foresight: the global superpower rivalry would lead to increased geopolitical tensions and rearmament. This laid the foundation for the Finserve Global Security Fund.
“When we delved deeper into it, we agreed with the foresight. We saw a long-term structural growth trend, and defense stocks are not as sensitive to economic cycles and inflation as other stocks,” says fund manager Joakim Agerback.
He emphasizes that the fund’s advisors, including former army chief Major General Karl Engelbrektson, play a crucial role in the strategic direction and risk assessment.
The fund was launched in February 2019. The goal was not necessarily to outperform the market in the long run, but to outperform during periods of high geopolitical uncertainty and thus contribute to risk diversification in clients’ portfolios.
Since Russia’s full-scale invasion of Ukraine on February 24, 2022, the fund has yielded 76%, compared to 23% for the Stockholm Stock Exchange. The largest holdings include Kongsberg Gruppen, Rheinmetall, Leonardo, Booz Allen Hamilton, CACI International, and Saab. All of these companies have benefited from the world’s rearmament and have more than doubled in value since the invasion.
“The companies are growing significantly,” Agerback notes.
The gains have led several analysts to highlight the valuations as a risk. Ålandsbanken recently took profits in Saab, and in April, several European defense stocks plummeted after American investment bank Goldman Sachs pointed out historically high multiples. The bank warned that companies’ supercycles typically follow the same pattern: first, two years of appreciation, followed by one to two years of trading at peak multiples before growth finally slows down and valuations decline.
Agerback believes that the sector may continue to trade volatily, but he is not concerned about overvaluations. He argues that it would be strange if price tags were not high, given the unparalleled growth prospects.
“The companies are growing significantly, and many have the potential to maintain or improve their margins, so P/E ratios will gradually come down as a result of that.”
The manager emphasizes that the defense investments being implemented and planned are not something that will be withdrawn at a moment’s notice. Furthermore, only a small portion of the investments has reached the industry and begun to show in the financial statements.
“We believe that the investment theme will last for at least 10-15 years, almost regardless of developments in the world. Since these are significant costs, the systems purchased should last for at least 20 years, with various additional orders. So the investments will be stretched out over a long period.”
Europe is also ramping up its defense spending, with several NATO members needing to increase expenditures to reach the goal of a defense budget of 2% of GDP.
But I think Trump will demand more. In addition, there is a common European strategy to order 50% from domestic suppliers. In recent years, they have imported nearly 80%, so just that difference can do a lot for companies like Saab and Rheinmetall,” Agerback points out.
He sees “very positively” on Saab’s prospects and believes that the price increase can continue.
“They are continuously receiving orders and seem to have found their niche with a good product mix. Just like Rheinmetall, the company is also central to the long-term investments currently being made in Europe.”
German Rheinmetall is one of the defense stocks he believes most in as a long-term investment.
“They have a wide range of traditional defense products in vehicles, ammunition, sensors, and the like. The company is making significant co-investments to build up its production capacity, and there is predictability in the orders. Here, you get exposure to structural growth over time, and I believe the stock has good potential to continue to perform strongly going forward.”
The manager also advocates for American Aerovironment, which develops drone systems and was recently added to the fund. The company is on an upward trend in profitability and is expected to grow by 15-25% in the coming years.
“Aerovironment has products that we believe will be of interest to Europe but also to other regions, as warfare becomes increasingly high-tech. Europe has fallen behind China and the US in this area and is likely to need to import a lot of these things,” Agerback says.
Two other recently added holdings are Mildef and Invisio, both mid-cap companies on the Stockholm Stock Exchange. Agerback’s thesis is that the increased defense spending first impacts the largest players, before trickling down to the smaller companies and suppliers.
“Mildef is a typical example of this as they can deliver to both BAE Systems and Saab. The company has already started to receive larger orders and will benefit from the second wave in the defense industry,” he says.
“Do you have the easiest job in the fund world, where you can just sit back and let Putin and Trump do the work for you?”
“Well, maybe right now, but we try to have a humble approach. Even though the underlying trends are in our favor, it’s important to manage both the upside and the downside risks. Incidents can occur that are difficult to predict and have a significant impact on individual stock prices,” he says.
The manager has experienced sudden downturns in several of his stocks. Cybersecurity company Crowdstrike plummeted over 40% last summer after conducting a software update that caused millions of Windows computers to crash. Defense conglomerate RTX took a billion-dollar hit last year due to a manufacturing defect, and the former holding Boeing fell when a door part came loose during a flight.
“Events like these underscore the importance of having a diversified approach to this sector,” Agerback concludes.