The conflict in Ukraine is a stark reminder that global conflicts can quickly shake up the market. When a conflict breaks out across borders, it can disrupt supply chains, ripple into state-wide sanctions, drive market-wide panic, and pull economic markets in several different directions. However, defense ETFs have an inherently defensive nature, and they might mitigate your portfolio risk when tensions peak. 

Still, before you invest in defense ETFs, it’s wise to understand their advantages, disadvantages, and inner workings. In this article, we explain how defense ETFs work and how investors can fit them into an investment strategy.

What Is a Defense ETF?

A defense ETF is an exchange-traded fund (ETF) underpinned by defense contracts, defense-related products, or the aerospace industry. Because they’re rooted in the defense industry, these ETFs tend to grow in value when geopolitical tensions rise and conflicts escalate. 

Still, there doesn’t necessarily have to be a full-on war or aggressive geopolitical event for defense ETFs to thrive. In many cases, the U.S. government will increase defense and aerospace spending to preemptively stop conflicts or prioritize national security interests. 

However, there are potential weak spots in defense ETFs. Although these ETFs usually focus on well-established companies, the defense industry tends to experience slower growth than other sectors. It also runs off of government spending, so when the government is pressured to reduce the U.S. defense budget, it could negatively impact traditional defense ETFs.

How to Use Defense ETFs to Defend Against Risk

Investors can use defense ETFs to shield their portfolios if the market feels shaky during geopolitically tense times. Defense ETFs can mitigate portfolio risk in two key ways: 

1. They can reduce financial damage during conflicts.

When used strategically, defense ETFs can act as a "defensive" play for your portfolio by potentially lowering overall risk during tough financial situations. For instance, if geopolitical tensions rise in an area in which fighting or sanctions threaten international supply chains, that event could lower market value across several sectors. However, these same events have often led to an uptick in defense spending. That means defense ETFs may add potential "security" to your portfolio of securities.  

2. They can add stability during moments of uncertainty.

You may be able to use defense ETFs to stabilize your portfolio in the long run. That’s because U.S. defense spending tends to grow over time. In fact, according to a Macrotrends report, the U.S. defense budget has increased every year since 2017. And according to Statista, defense spending is expected to increase annually until 2032. 

Long-Term Benefits of Defense ETFs

Defense ETFs can support a long-term investment strategy. Because defense contractors work with the U.S. government, they tend to be highly vetted and established. That means they may carry less risk than the general market. 

Still, not every defense ETF will provide the same level of "protection." Defense ETFs will only be as diversified as the collection of companies they’re built on. That’s why specialized defense ETFs, such as Emles’ Federal Contractors (FEDX) ETF, may add extra value when less-diversified defense ETFs sputter. 

The FEDX ETF includes companies that hold high exposure to U.S. government contracts. These specialized ETFs aren’t bound exclusively to traditional aerospace and defense contractors. Instead, they offer more diversification by reaching across sectors into the spaces in which federal spending shifts, such as technology or healthcare. 

Defense Includes Broad ETF Advantages

As an investor, it’s crucial to understand that many of the advantages of defense ETFs stem from how they’re packaged. Here are a few advantages of ETFs:

Learn More Ways to Sharpen Your Investing Strategy

Investing in defense ETFs is just one possible move you can make to execute your investing strategy. There are more ways to increase your investing knowledge and help work towards your financial goals. Subscribe to our blog to receive free resources, tips, and insights in your inbox. 

Tags: Federal Contractors